January 20, 2003 – One of the most important things to do when managing an investment is to stay aligned with the primary trend. This principle is true for every market and every investment – stocks, bonds, commodities, currencies, etc. You name it.
You may have even heard the catchphrase that ‘the trend is your friend’. Truer words have never been spoken when it comes to investments.
The trouble is, as simple as it sounds, staying aligned with the primary trend is one of the most difficult things to do in investing. There are always distractions that can get you sidetracked, or to cause you to take your eye-off-the-ball. So for that reason, it is useful to have some mechanism to help keep one aligned with the primary trend. When it comes to gold, the mechanism I use is my Fear Index.
For the benefit of new subscribers, the Fear Index is calculated as follows:
|(US Gold Reserve) * (Gold’s Market Price)|
|———————————————————————-||= Fear Index|
I calculate the Fear Index monthly, on the last day of the month. The Fear Index was 1.06% as of December 2002.
|(261.5 million ounces) * ($347.00 per ounce)|
I want to explain how to use the Fear Index to stay aligned with the primary trend for two reasons. First, a lot of subscribers have been asking for some guidance about their gold mining stocks. Should they sell? Should they buy more? Questions like these are important, and can only be answered when viewed within the context of the primary trend.
For the dollar, the primary trend remains down. Conversely, for gold and the gold mining stocks, the primary trend remains up, which is to be expected given the dollar’s downward trend. So as a consequence, I have been recommending that readers continue accumulating gold and the gold mining stocks.
There is a second reason I want to explain how to use the Fear Index to stay aligned with the primary trend. I use the Fear Index to project the gold price, thereby providing a future price target upon which to focus. Projections can help us stay aligned with the primary trend because a price target can often keep one focused on any market’s potential.
Projections, however, are a dime a dozen. I therefore do not want to just pull some numbers out of the air and claim them to be a projection. Rather, if I am going to project the future price of gold, I want the projection to be based on logic, and this is where the Fear Index comes in. My gold price projection uses the Fear Index and an important principle – namely, that history repeats.
I have been making the case in these letters that gold today is not unlike gold in 1971 – out of favor and very undervalued. So to project the future price of gold, I will use the Fear Index from that time, which is ‘buy signal’ #1 on the accompanying chart.
In other words, I will project the gold price by first projecting what the Fear Index will be in the future. And I will make this projection of the gold price simply by showing what would happen if history repeats, and the Fear Index over the next eighteen months does what it did for the first eighteen months after triggering its first buy signal on the above chart.
My projection of the gold price is presented in the following table. It projects gold to be $366-$367 at the end of this month, with a high of $934 in February 2004. Here’s how I derived these projections.
To begin, I will start by analyzing the first buy signal. It was triggered in May 1972 at the gold price of $59.40, which was already well above the $35 price that had prevailed. But it took several months after President Nixon closed the ‘gold window’ in August 1971 for this signal to be generated.
Remember, two events are needed for a buy signal. The Fear Index must be above its 21-month moving average and this average itself must be rising. Those two events were only met in May 1972 when the Fear Index was 2.01%, and the moving average was 1.73%.
Buy signal #5 was generated when these two events were both met in May 2002. The Fear Index that month was 1.05%, and the 21-month moving average was 0.96%. Thus, the Fear Index buy signal given in May 2002 was at a much lower absolute value than buy signal #1.
In order to adjust for this difference in the Fear Index at these two dates, my next step was to calculate the month-to-month percentage change in the Fear Index from June 1972 through June 1974. My basic assumption is that the Fear Index over the next eighteen months will make the same gains that it did with its first buy signal. So this simple and straightforward calculation of the percentage gains in buy signal #1 enabled me to project the Fear Index for the next eighteen months to June 2004.
In other words, I am simply assuming that the Fear Index over the next eighteen months repeats exactly what it did (as measured by month-to-month percentage changes) in the first eighteen months after generating its first buy signal. These projected values for the Fear Index for January 2003 to June 2004 are presented in the page 1 table.
Once I had established the future Fear Index, I needed to project two other components in order to determine the gold price. For these, I assumed that the US Gold Reserve remained unchanged at 261.5 million ounces. My projection of M3 was somewhat problematical, so I used two different assumptions.
In the first assumption, I assumed that M3 takes the exact same growth track that it did in 1971. See again the page 1 table, with these values for M3.
Upon reflection though, I thought these growth rates might be a little high. So in order to provide a second and alternative projection, I then calculated M3 for the next eighteen months at a constant 7.5% annual growth rate. This rate is consistent with recent results, with monthly M3 growth in 2002 having averaged an 8.0% per annum growth rate.
Having now established these different components of the Fear Index formula, I could now solve for the unknown, which of course is the gold price. In this pure mathematical determination, I project the gold price to reach a high of $934 in February 2004.
Impossible you say? Well, why is it impossible? That kind of price appreciation has already been seen, as it simply mirrors what happened in the early 1970’s. If it happened once, why can’t it happen again?
It can happen again, and I think it will. If you still think this level of price appreciation to be impossible, look again at the page 1 chart. My projection of the Fear Index is presented there along with its 21-month average based on these projections (see the dotted lines).
One can see from this chart that the projected result is not outrageous. It exactly mirrors the early 1970’s results, and is more subdued than the late 1970’s results. What’s more, just looking at this chart from a purely technical perspective, one could easily say that the projected Fear Index looks to be a quite normal result that is to be expected when viewed within the thirty-five years of history presented in this chart.
Given that there are two different M3 projections in the page 1 table, there are two different gold price projections for each of the next eighteen months. I would use these two projections together, identifying a potential range for the gold price. Thus, my projection for February 2004 is that the gold price on the last day of that month will be somewhere between $934 and $908.
So, having made these projections, what do we do with them? First, I’ll tell you what not to do.
Don’t run out and mortgage the ranch to buy gold. These projections are simply that – projections that present one possible future outcome. And clearly, this future outcome is not assured, but then again, this outcome cannot be dismissed either.
Therefore, my recommendation is to do what I always recommend doing in these letters. Let’s just take one month at a time, positioning ourselves accordingly by accumulating gold and the gold mining stocks. Further, and perhaps most importantly, let’s pursue this ongoing accumulation strategy while continuing to recognize that the primary trend for gold is rising, and the primary trend for the dollar is falling. It is these two primary trends that I think will have the most important effect on everyone’s wealth for the next few years.