I would like to present a brief discussion quantifying the leverage available in the HUI. This work builds on two recent Gold-Eagle essays ("Mining the XAU for Gold" and "Looking for Leverage"). In the first essay, Zelotes (a.k.a. Adam Hamilton) and I drew conclusions based upon 18 years of data for the spot price of gold and the XAU. In the second essay, I introduced a linear trend line for the XAU compared to the price of gold and then drew conclusions based on this finding. One of the most revealing conclusions was that if one was looking for leverage in the mining shares, then one might well look at the unhedged shares such as NEM, HM, and AEM within the XAU … and avoid emulating an XAU distribution in one's portfolio.
In this same data set obtained by Zelotes, was data for the HUI from about June of 1996 through June of 2001. It is this data set that was used for this subsequent analysis. As in the essay "Looking for Leverage", we introduce a direct relationship between the POG and the HUI index which is time independent. The first data point in the graph below was generated as follows. Any price of gold greater than or equal to 250 and strictly less than 255 was added to the total and then normalized by the number of data points. The HUI values associated with these spot prices were also added and normalized. Thus, we have effectively looked at a "$5 bin" of gold prices to generate one (POG, HUI) data point. Note that individual contributions to this single data point may be separated by years in the overall data set. This procedure was repeated for increasing $5 intervals until the data was exhausted. Also plotted on the graph is the linear trend line (LTL) for the HUI vs. POG, and a line that represents the POG minus a fixed value of 200. Notice that the line represented by HUI = POG - 200 is a very good approximation to the linear trend line of the entire HUI vs. POG data set. For convenience, we will reference this approximation by calling it the "rule of 200".
At this point many of you may be saying … "so what's new here? … it seems like I've read this before" … to which I say "guilty as charged for the cut and paste". However, there is a fundamental difference between the "1/4 rule" introduced for the XAU in "Looking for Leverage" and the "rule of 200" that we just derived. In the previous paper we warned that emulating the XAU simply led to a 1-to-1 move relative to the POG. This is not the case with the HUI.
For simplicity, we will illustrate the leverage in the HUI using the rule of 200 for a specific example. Suppose gold moved from 300 to 400 (or a 25% increase). Then using our rule, the HUI would go from 300-200=100 to 400-200=200 (or a 100% increase) … a 4-to-1 leverage … looks like we are "Finding Leverage in the HUI". One could potentially do well in a rising spot price environment by emulating an HUI distribution. The reader may easily compute this leverage for alternative examples … please use caution as to the applicability of the "rule of 200" outside of the data range specified in the graph above.
In closing, let's take a step back and look at the broader context of both the HUI and XAU conclusions that have been drawn. It seems fairly obvious that the hedged producers in the XAU are greatly damping the leverage. Further, there is nothing magical about the particular stocks in either the XAU or the HUI. We learn early that risk is inversely proportional to the number of stocks in one's portfolio. Thus, for the overall percentage that one wishes to invest in gold shares, one may reduce the risk of this percentage of one's portfolio by increasing the number of stocks comprising said percentage. One may then use a variation of this analysis to maximize gains. Gold mutual fund managers or large mining share investors may do well to invest in such analyses, should they be able to justify the expense.
14 June 2001