Tuesday, October 03, 2006

Looking at global share indices

Sol Palha's recent contribution to Financial Sense is an overview of world markets entitled, "Dow 11700 and Other World Indices".

What's interesting about this piece is that moves in the world share indices are measured against the movements in their respective national currencies, as is the Dow Jones Industrial Average against the dollar.

From this viewpoint, Palha comments on the real underlying strength of the various international share indices versus the Dow. Here, Palha explains why it is important to look at the market's performance in tandem with its currency strength:

Currency devaluations or gains play a very significant role in market direction. The masses do not understand their significance and hence fail to recognize and understand what the main ingredients for a true bull are. Once you have knowledge of how currencies work you can then sit down and slowly position yourself for the larger long term moves. If the Dow should trade past 12000 almost every regular individual who has no knowledge of the currency markets will state that the Dow has put in a new high.

You may have seen this philosophy repeated in the works of Richard Russell and Marc Faber, who are also careful to point out the effect of currency devaluations on asset prices. Often, I have seen them (and others) measure a market index in terms of gold. This gives us a view of how market "X" or (asset "Y") has performed in real terms, for gold is the only form of money that has kept its purchasing power intact over time.