Fear Index update: June 2012

Savings and liquidity have value, especially in times of uncertainty, and so does insurance. Gold is money and it is also insurance against the failure of fiat currency. How much is it worth to protect your hard earned wealth from the arbitrary decisions and regime uncertainty that permeates the world of monetary policy?

The simple fact is that people around the world – particularly in Asia – are willing, as many have been for generations, to save in gold. They know that whatever happens to political systems, currencies and nations, their gold savings will probably outlast them. They do not need to be encouraged, persuaded or coerced into owning gold. They choose to use it as a store of value freely.

Some economists have argued that the supply of gold can change as more gold is mined and discovered. Projects to mine asteroids or the bottom of the sea are cited as dangers to the stability of the world gold stock. This argument is perhaps valid at some level, but let us put things into the proper perspective: the Federal Reserve can create a trillion dollars at the touch of a button; but to mine gold in the asteroid belt would require a space programme of epic proportions and is beyond our present technology. The supply and demand forces at work in the world of gold money are light years slower than those in the fiat-currency world of central banks. This simple reality is why some people, namely those in control of the printing press, resist so fiercely the idea of gold as money and fought so long to banish it. Cui bono indeed.

Gold’s worth is clear, but is there a better way of quantifying it? That is where the Fear Index becomes extremely useful, by using the official Bretton Woods equation, rescued by James Turk, to measure the relative value of gold, its exchange rate to the dollar, by comparing the quantity of dollars in circulation (measured in M3) to the US Treasury’s stock of gold which once backed the dollar notes in circulation. It gives us a good idea of just how undervalued gold is and how high its exchange rate could go when faith in the dollar and its sister fiat currencies is shaken. The Fear Index rose to 10% in the dollar panic of the 1980s, and to 30% during the Great Depression. After bottoming at just under 1% in 2001, today it stands below 3%, laying to rest accusations of a “gold bubble”. It has been rising for more than a decade, but even though the tide has turned it still has a long way to go for gold to even approach fair value. Gold’s potential is huge.

After a small pause in 2010, the supply of dollars continues to grow. The euro crisis has increased dollar demand and US M3 could surpass $15 trillion this year. When that happens there will be over 1,800 fiat dollars for every single gram of gold held in the US gold reserve. This is over $57,000 for every single ounce. Even if the Fed were to hold still, which is unlikely, gold would be massively undervalued.

When the fiscal and monetary excesses of Keynesian economic policies start to affect confidence in the dollar and threaten its reserve currency status, the Fear Index will show us how high gold can go.

Perhaps that is why central banks are expected to buy over 500 tonnes of gold in 2012. They would not do it if gold were “just another commodity”.

James Turk has been writing about the Fear Index for years, as you can see at his Free Gold Money Report website.