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By Kenton Ralph Toews

The chart below has been making its rounds as of late. It is a ratio of the S&P GSCI Total Return Index, a basket of commodities, to the S&P 500. It paints a very interesting picture of where commodity prices are in relation to general equities. Relative to general equities, commodities are the cheapest they have been in almost 50 years.

GSCI Total Return/S&P 500, Source: Bloomberg Monthly Last Price, Kenton Ralph Toews, Date: March 30, 2018.


Notice the GSCI is a total return index and the S&P 500 is a price return index. Hence, the chart above compares a total return index with a price return index. A total return index accounts for the effects of compounding by including the reinvestment of cash distributions and dividends. By contrast, a price return index does not take into account cash distributions and dividends and, therefore, ignores the effects of compounding.

For these reasons, over time, a total return index will outperform its corresponding price return index.


For consistency, when comparing two indexes we should consider either the total return or the price return of both. The popularity of the S&P 500 price return index suggests a good starting place.

GSCI Total Return ratio compared to GSCI Price Return ratio, Source: Bloomberg Monthly Last Price, Kenton Ralph Toews, Date: March 30, 2018.

The price return comparison of the GSCI and S&P 500 paints a much different picture than the original, widely publicized, chart. This chart suggests that commodities, relative to general equities, are even cheaper than reported. Furthermore, the commodity bull market of the 2000s barely registers a blip on this chart — it was nothing compared to the commodities bull market of the 1970s.


To put the above charts in context, we should break down the GSCI. The GSCI is an index composed of individual commodity prices.

GSCI Composition, Source: S&P GSCI Index Methodology, Kenton Ralph Toews, Date: February 2018.

Energy is by far the largest component at 58% followed by agriculture at 26%. Together, the two components represent 84% of the index. Therefore, it is more appropriate to say energy and agricultural products relative to general equities are the cheapest they have been in the last several decades.


How cheap is gold relative to general equities right now?

Gold/S&P 500, Source: Bloomberg Monthly Last Price, Kenton Ralph Toews, Date: March 30, 2018.

Right now, the Gold/S&P 500 ratio is approximately 0.5, which means one ounce of gold will buy half a unit of the S&P 500.

Seventy-seven percent of the time, the Gold/S&P 500 ratio is above 0.5. Fifty percent of the time, the ratio is above 1.0. Over the last 90 years, the average Gold/S&P 500 ratio is 1.4.

To keep the math simple and to be conservative let us assume mean regression will take that ratio to 1.0 at some point.

As I write, gold is approximately $1,335 a troy ounce and the S&P 500 is around 2,685 To achieve a Gold/S&P 500 ratio of 1.0 at the current S&P 500 level, the gold price would have to double to $2,670. On the other hand, if gold stays constant at $1,335, the ratio implies an S&P 500 at half its current level.

Ultimately, it does not matter whether the S&P 500 goes up or down. If history is a guide, and the ratio trends upward, gold will outperform general equities from a relative point of view.