Revisiting "The Rule of 200" for the HUI
PMtrader
In a prior essay entitled "Finding Leverage in the HUI," a simple relationship was introduced that equated the performance of the HUI to the price of gold (POG). Simply stated, it was found that when the HUI was plotted versus the POG, the linear trend line was well approximated by HUI ~ POG -200. Thus, in the sense of averages, a rule was developed for expected values for the HUI as a function of the gold price - with the idea of gaining a perspective on when the HUI might be undervalued.
In the discussion that follows, the analysis was updated with the latest data, ranging from June, 4 of 2000 through May, 7 of 2004.
How the relationship was developed is worth repeating. For the following analysis, daily data was scanned. Any price of gold greater than or equal to 250 and strictly less than 252 was added to a total and then normalized by the number of data points. The HUI values associated with these gold prices were then added and normalized. Thus, a "$2 bin" of gold prices was used to generate one (POG, HUI) time-independent data point. The process was repeated for increasingly higher bins, until the data was exhausted.
Note that individual contributions to a single data point (bin) may be separated by years in the overall data set. Now, let's talk about the results shown in the first plot.
The blue line represents the "HUI bin data" and the purple line represents the price of gold minus 200 - called the "Rule of 200". The dark red line is the linear trend line for the HUI data. It is approximately equal to 1.23 times the price of gold minus 278 as shown on the plot. The reason for this change to the linear trend line is straightforward. First, gold has achieved higher prices since the last paper was written and second, the range of data chosen for this investigation concentrated on the last four years as previously mentioned.
While the "Rule of 200" is still a good rough approximation, the errors grow with increases in the price of gold. For example, the "Rule of 200" predicts an HUI value of 300 for a gold price of 500, whereas the new formula implies a value of almost 340.
A final note is warranted concerning the previous plot. What is the green line? The green line is a count of how many days the price of gold traded within a particular bin. Thus, as an example, you can see that in the last four years, there were over 100 closes for gold in the 274-276 price bin - 22 closes in the 408-410 bin, etc.
Now let's look at a second plot, which clears away the averages and focuses on the raw data - as well as focusing on where we are trading right now.
Friday's closing values (May, 7, 2004) are highlighted with the red dotted lines - the green dots represent the intersections with the data. What are they telling us? First, the current gold price as shown with the vertical line implies that the HUI index should be trading at about 200 - based on averages over the last four years. Second (or alternatively), the horizontal value representing Friday's HUI close implies that gold should be trading at about $371 - again in the sense of averages.
Certainly the work presented is not predictive on a day-to-day basis. However, just like moving averages give guidance in data analysis, so too this plot above tells us that there is "pressure" in the gold market, pressure to return to the mean.
There is a final consideration, which is perhaps the most interesting of anything discussed so far. Note that the HUI's value is just below the middle of a steep slope in the functional relationship. What this means based on four years of data is that very little movement in gold (when the HUI is in this steep slope) tends to lead to large changes in the HUI.
Simply said, a five to ten dollar increase in the price of gold could well lead to a quick thirty point increase in the HUI index. Conversely, the spot price of gold would have to break below 355 to cause the HUI to break below 150. Please be reminded. These last statements are made in the sense of averages - or in the sense of price pressure, as opposed to price guarantees.
PMtrader
Now on a personal note and as I mentioned in my last essay - I have written a fictional novel entitled "Eye of the Pyramid" and hope to have it in print before Christmas this year. Many of you have written me emails of support. Thank you.
I would like to take this opportunity to let you know that I will not be accepting orders until a publication date is set, but a special thank you (!) to those who wanted to order a signed copy already.
If you did not see my last article, which gave a brief description of my novel, you can read about it in "The HUI Spread in the Golden Bull." Let me know if you find my work of interest. All the best ... PM
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