Two Important Messages from the Fear Index

January 20, 2010 – The Fear Index remains within its decade-long bullish uptrend, so we therefore know as a consequence that gold also remains within an uptrend. But the Fear Index is also giving us another important message. It is that gold remains undervalued.

Gold’s valuation is indispensable information given its exceptional appreciation this decade. In other words, even though gold has risen nine years in a row against the US dollar, it remains relatively cheap. This conclusion is illustrated with the following chart.

The dashed horizontal line on this chart marks 2.63%, which is the average value of the Fear Index since August 1971. That is the date when President Nixon – with total disregard to the US dollar’s 180-year history – turned the dollar into irredeemable fiat currency, in effect declaring by presidential edict that the monetary requirements of the Constitution were null and void.

The Fear Index is presently 2.05%. Note that it is lower today than August 1976 when the Fear Index was 2.28% and gold was $104. Therefore, gold at $1106 – its December 31, 2009 price – is even more undervalued than it was at $100 back in 1976. How is that possible? How can gold be more than 10-times more ‘expensive’ today and still be better value?

Simple. A 2010-dollar is not the same as a 1976-dollar. The dollar’s name has not changed, but the dollar has been terribly debased over the past 34 years. It has lost much of its moneyness – its innate value as money – in two insidious ways.

It has lost purchasing power because of inflation. Secondly, it also has 0.23% less gold-backing today than it did at the low point of the Fear Index in 1976. Even though dollars can no longer be redeemed for gold, dollars are still partially backed by gold. The Fear Index measures to what extent gold backs the dollar, assuming of course that the 261.5 million ounces in the US Gold Reserve really exist and have not been loaned out, encumbered or put in play as part of the gold price suppression scheme led by the US government.

What is clear from the above chart is that one cannot use the dollar price of gold to determine whether or not gold is good value. The purchasing power of the dollar and the extent of its gold-backing are ever-changing. So the dollar is not a good measuring stick. It is not a numéraire.

The important conclusion from the above chart is that gold remains relatively cheap. We should therefore continue to accumulate it.

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For reference, the formula to compute the Fear Index and the value for the Fear Index as of December 31, 2009 are as follows: