Could the S&P 500 to Gold Ratio Be the Most Important Chart in Macro?

By Adam Thurgood on March 7, 2023

Nearly every investor believes stocks go up over the long run.  Generally speaking, they’re right if you zoom out far enough, as the chart we’re all familiar with below visualizes.  Academics, like Jeremy Siegal, have been pounding that belief into investors’ heads for decades and Davey Day Trader took that message to a whole new level during covid with his “Stocks Only Go Up!” mantra.  However, anyone with experience knows that markets can be downright brutal for long stretches.  One only needs to read a monthly thought piece from John Hussman to get a sense of why these stretches occur.  But alas, for now, the buy-the-bleeping-dip (BTFD) mentality seems alive and well, despite a change of tone from central bankers. 

The chart below shows a clear and consistent relationship between the S&P 500 and the money supply (M2 index), at least until recently.  In some way, it’s hard to blame the BTFDippers for pushing stock prices back up because central banks have consistently come to the rescue.  Despite raising rates past the point many of us thought possible and continuing to talk tough, markets haven’t broken, and the Fed hasn’t had to make the ultimate tough choice between protecting markets or fighting inflation.  That day may be coming, but until then the collective market view is that the printer will eventually turn back on. 

With all the excess money that has been produced over the past few decades, a lot of strategists, including myself, have started to deflate the price of assets by some money-related factor to get a better sense of what is really going on under the hood.  I tend to think of gold as the, pun-intended, “gold standard” for long term money, so for this exercise I have priced the S&P 500 in gold, as shown in the chart below in gray. 

As you can see rather quickly, when priced in gold, the S&P 500 looks nothing like its stand-alone chart.  What’s also clear with a quick look is that there are long stretches, as in decade plus periods, where the S&P 500 underperforms gold.  Granted, gold was fixed versus the dollar up until the early 1970’s, so the S&P 500’s performance relative to gold before that time was purely the result of moves in the S&P.  However, since the price of gold began to float versus the dollar, the S&P 500 to gold ratio has been both a function of changes in stock values and the change in gold.

So why is this chart so important to macro?  Two reasons.

Reason 1

If history is any guide, the S&P 500 to gold ratio will continue to trend in long cycles.  This creates opportunity for portfolio positioning when cycles turn.  Using a simple 12-month and 48-month moving average provides the backbone for a positioning strategy.  As you can see from the chart below, the 12-month moving average (orange), tends to bounce off the 48-month moving average (blue) during both expansions and contractions in the ratio. 

Except for a small outlier in 1977 and the Covid crash, a cross of the two moving averages (in excess of a small margin of error) has been a great indication of a long-term trend change.  I ran the numbers on returns over this time horizon and found following this strategy yielded great results.  The annualized S&P 500 price return since 1950 is 7.8%, while the annualized return of gold is 5.6%.  Using an all-or-none approach where a portfolio is either positioned in the S&P 500 if the trend is positive or in gold if the trend is negative, yielded an average annualized return of 10.7%.  Over a 70+ year period, that alpha adds up!

The S&P 500 pays dividends, so a price return isn’t the fairest of representations of the value of a $1 invested, so I ran the same analysis using the S&P 500 Total Return Index going back to its inception in the late 80’s (due to the need for a four-year average, the return data starts in the early 1990’s).  The S&P 500 annualized return over this period was 10.0%, gold 5.3%, and the strategy produced 12.2% returns.  Again, solid! 

Needless to say, one should pay attention to turning points in the ratio.  Today, we are awfully close to a change in trend, as indicated by the zoomed in version of the chart below.  For now, the indicator suggests staying long equities versus gold, but that might change in the not-too-distant future.  What could cause a trend change?  Plenty, but that is for another piece. 

Reason 2

As I was noodling around with the charts I began wondering if this was all dollar related.  When I pulled up the moving averages of the dollar index (DXY) alongside the S&P 500 total return to gold ratio, I was quite surprised by what I saw.  The 12-month moving average of the dollar lagged the 12-month moving average of the S&P 500 total return to gold ratio by about 12 months with fairly high correlation (85%). 

I would have been scratching my head for a while thinking through this chart if it wasn’t for a piece of research my buddy Julian Brigden wrote a couple of months back.  In his piece, he demonstrated that the dollar has been the beneficiary of flows into US equities, especially the big tech names.  While foreign purchases of treasuries lagged, the current account deficit was more than offset by the likes of the Swiss National Bank FOMOing into FANG stocks.  The relationship between the dollar and the S&P 500 to gold ratio is further evidence this phenomenon exists and is important to watch.

Anyone on FinTwit in 2022 could not avoid the constant bombardment of “dollar wrecking ball” references and how the chart of the dollar was the most important chart in macro.  The dollar’s value is hugely important to global asset prices, so all those references were justified.  Given the leading relationship between the S&P 500 total return to gold ratio versus the dollar, perhaps there is an even more important chart in macro that investors should pay attention to; one that appears to be rolling over.