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The celebrated demographics forecaster Harry S. Dent Jr forecasts a stock market crash by the end of February in his New York Times Bestseller ‘The Great Depression Ahead: How to prosper in the debt crisis of 2010-12′.

From around 10,000 today he has two scenarios for the Dow Jones in 2010: one, a fall to 3,300-4,600 in a broad crash also taking down real estate and commodities, including gold and oil; second, for the Dow to go even lower to 2,200-3,500.

Mixed track-record

Both are apocalyptic for stock market investors. Harry Dent made his name in the early 90s with a counter-consensus and very accurate, super bullish prediction about the outlook for stocks. His specialty is the study of demographics, or population trends, as a means of forecasting the future.

In his current book he apologizes some past errors, with a real howler being a stock market bubble in the late 2000s that just never happened or came close. Indeed, he is almost humble about noting the complexity of intermingled cycles that make forecasting tough.

Yet he has made some good calls in the past and his use of demographics is original and based in solid statistical information about population trends. There is also truth in his contention that the broad trends he mapped in his first forecasting coup in the early 90s did include an big downturn in 2009-2012.

Aside from his demographic analysis, Mr. Dent stands as a deflationist. He cooly says that all the government spending in the world will not offset the deflationary impact of a private sector collapse in business activity and trade, driven by falling consumption and a house price implosion.

Sometimes the simplest observations prove to be the best guides to future stock movements. For if this statement on deflation stands up then financial markets are currently way overvalued and heading for an imminent fall.

What is surely interesting for stock market investors is that Harry Dent is standing back from the day-to-day noise of the market. He is not talking about Greek or Dubai debt. He is not worrying about the latest unemployment or housing figures. His analytical model saw this coming twenty years ago.

Investment insight

For the full analysis you should read his very cogent book. But the obvious immediate implication is that stock market investors should sell now and not dally around. It is probably too late to sell real estate but certainly do not buy anymore.

Mr. Dent is negative on the immediate outlook for gold as he thinks the yellow metal will suffer along with all commodities in a rush to cash and short-term bonds. Thereafter Dent thinks there will be some great opportunities to buy long-term US bonds at high yields but curiously he does not foresee a rush to gold as bonds crash.

Harry S. Dent has been very wrong in his forecasts in the late 2000s but he seems on much more solid ground now with the Dow dipping under 10,000 last week. It is just very hard to come up with a positive alternative scenario that would save the long rally.

It is fairly easy to understand the obvious link between the greater availability of credit and rising asset prices. But less obvious is the rolling up effect or compounding of relatively small annual gains in value over very long periods of time in a credit boom.

In June this correspondent will go for a reunion of alumni in Oxford after almost 30 years of absence. Since then the price of a cup of tea on British Rail is up six-fold. The value of our former family home by a factor of 18.

Precious metal prices static

Silver is actually worth less than it was in 1980 and gold is only slightly higher. Graduates are paid around five or six times more than in 1980 when they start their first job.

Share prices are another interesting comparison to make, up around 12-fold since then but unchanged over the past decade. Houses do seem to stand out as exceptionally overvalued, at least in relation to precious metals, British Rail tea, average incomes and even stocks.

The UK housing market is a classic credit-driven asset bubble. Over time the banks have worked tirelessly to keep mortgage debt at a constant proportion of income, thus most of the benefit of falling interest rates has been lost on the general population and pushed up house prices instead.

People have also been brain washed over time into thinking a home is your best investment and can not go down (despite the 1991-3 evidence to the contrary). It is a national mania for home ownership, and even in a massive recession people are very reluctant to let go of their dream home or loss-making investment.

Of course looking back to 1980 that was the very moment to buy a UK property and sell up gold and particularly silver – which were then in an investment bubble after a decade of inflation and recessionary conditions.

Sell property, buy gold

Is not the lesson now that those caught up in the global property bubble – which is still only in its early stages of deflating if history is any guide – ought to be selling up and buying precious metals next for the upcoming multi-year upward compounding of gold and silver prices?

It is never a straight line up for any asset class. But for example that nasty 1991-93 phase in UK housing only looks a blip on the chart, although it bankrupted many young property owners at the time.

However, getting on the right side of the rising trend (and getting out of a falling trend) is the key to successful long-term investing. Ask anybody who bought a house in Britain over the past 30 years. But a rising trend is never without an end.

Obvious trends

For stock market investors the long-term trend is surely also a warning sign. The credit inflation of the 2000s has barely managed to support price levels, so how can they possibly be maintained in an era of de-leveraging and tight credit?

Surely anybody can see that near zero rate interest rates cannot last forever. And if asset prices are only being held up by low interest rates what will happen when they go up? Asset prices have to come down. This is a selling opportunity for property and stocks, and a buying opportunity for gold and silver.

If the Dow Jones Index is expressed in the only currency that does not inflate over time then the ongoing bear market is very clearly visible, with the rally of last year nothing more than that, and we have to ask how will this ratio proceed until it reverts to the bottom of one last seen in 1980.

Then the gold price was $850 an ounce and the Dow index highly depressed during the last big US recession. Looking at this chart and extrapolating forward then gold prices look to be going much higher, while the Dow Jones is in for another downturn.

Commodity boom

Simply stated it can be noted that over time gold, oil and other commodities have a reverse correlation to stock and real estate markets. One is rising while the other is falling, and vice-versa. The Dow:Gold chart shows this inter-relation very neatly.

So to revert to the long-term low point of one on this index almost certainly requires a combination of gold heading much higher in price and the Dow taking a tumble. And is that not what the bearish noises on Wall Street and the bullish babble from gold bugs is telling us?

Are we not heading into a couple of years of near depression like 1980-2 with stock market prices too high right now? Is gold not increasingly attractive to investors with bond prices looking very vulnerable in particular, once stocks have corrected?

Other scenarios

Try to turn it the other way round – which is also a way to the index point of one. Then stocks would have to fall by almost 90 per cent just to get to the current gold price, or the gold price would have to surge by a factor of ten to meet the current Dow.

Interestingly none of these scenarios is negative for the gold price. You would need to see the Dow:Gold trend broken entirely for that to happen, and what on earth could do that? Long-term trends in major asset classes are among the most reliable of indicators.

Given that the trend is your friend until it is not, then the Dow:Gold chart is a guide to serious investors about where to put your money for the next few years. Of course, this is a long-term trend, so a short-term setback for the gold price can still happen as the Dow first sinks, and might be expected as the dollar would rally strongly.

Goldman Sachs is forecasting a stronger than average turnaround in the fortunes of the UK economy this year but only because the value of everything in Britain has been devalued by 25 per cent with the collapse of the pound.

This seems a high price to pay for 3.4 per cent growth which Goldman thinks the UK will achieve in 2010, although not many other forecasters are as optimistic. This will compare to 2.4 per cent growth in the USA and 1.9 per cent in the eurozone.

Devaluation bonus

The fall in the value of sterling is expected to boost export growth, and attract inward investment from overseas. There are also hopes that the important UK financial sector will revive investment spending after last year recording the lowest level since the 30s.

However, export volumes will first have to make good the value lost in depreciation. Then there is a reliance on a continued upward movement in the global economy to support rising exports and inward investment. A double-dip US or eurozone recession would sink this prospect, and keep the UK financial sector on its knees.

The Goldman forecast is also predicated on a much longer period of ultra-low US interest rates than most economists accept, with effective zero rates until 2012. This would help to keep the pressure off the Bank of England to raise its rates.

However, foreign currency traders say the pound’s weakness may not last for long, and UBS is telling its clients to buy the pound against the euro. In that case the window of opportunity for UK exporters may close as quickly as it opened.

UK house prices

Some recovery in the UK housing market recently might also be seen as a harbinger of higher growth rates, with investment from overseas a factor at the top-end. But equally this is a sign of interest rates now set at dangerously low levels that are bound to result in unsustainable asset price inflation.

That is to say house prices that will come down quickly when interest rates finally go up. However, 2010 is surely a year of two halves for the UK economy: before and after the general election expected in May and by the latest in June.

Whichever party or coalition of parties is elected is going to have to raise taxes and drastically cut public spending and borrowing. That will dampen demand and return the economy to conditions that feel like a recession even if it is technically avoided. For no economy in history has ever devalued its way to growth in the long run.