The volatile NYSE Arca Gold Bugs Index (HUI)

Since a couple of years, precious metal miners are the absolute dogs of the stock market. Every recovery we enjoyed has rolled over, followed by an even deeper trough than the previous bear market bottom. Even before gold peaked in August 2011, miners had been lagging the rising price of the metal.

Composition

The current HUI index counts 18 list components. It necessarily is an average of better run mining companies and poor performers. In this article, I will not go into detail on the individual miners, but focus on the HUI index only. 

To start with the name "NYSE Arca Gold Bugs Index" has an acronym hidden, since 'BUGS' also stands for 'Basket of Unhedged Gold Stocks'. By 'unhedged' is meant that the total volume of their forward sales do not exceed one year of production.

Table 1: HUI components and closing quote as of November 5, 2014

Symbol	Name	Last Trade
ABX	Barrick Gold Corporation	12.50
AEM	Agnico Eagle Mines Limited	25.17
AGI	Alamos Gold Inc.	7.84
AU	AngloGold Ashanti Ltd.	8.81
AUQ	AuRico Gold Inc.	3.37
BTG	B2Gold Corp.	1.69
BVN	Compa (Companhia Buenaventura)	8.84
EGO	Eldorado Gold Corp.	5.70
GG	Goldcorp Inc.	20.32
GFI	Gold Fields Ltd.	3.15
GOLD	Randgold Resources Limited	59.16
HMY	Harmony Gold Mining Company Ltd	1.61
IAG	IAMGOLD Corp.	1.75
KGC	KINROSS GOLD CORP.	2.27
NEM	Newmont Mining Corporation	17.83
NGD	New Gold, Inc.	3.91
SBGL	Sibanye Gold Limited	6.81
AUY	Yamana Gold, Inc.	3.97

HUI index and its volatility

After calculating all day-to-day variations at the close, the distribution of those variations can be studied.  You find the main characteristics in the table below:

Table 2: Characteristics of the distribution of daily variations of the HUI.

Moments
N	4614	Sum Weights	4614
Mean	0.031335%	Sum Observations	1.44578535
Std Deviation	2.711457%	Variance	0.0007352
Skewness	0.6774	Kurtosis	6.812
Uncorrected SS	3.3919	Corrected SS	3.3915
Coeff Variation	8653.2	Std Error Mean	0.0004

N is the number of observations: going back to June 1996 that adds up to 4614 daily variations. The standard deviation of that distribution is quite high: slightly over 2.7%. This means that considerable rallies and cumbersome swoons are rather frequent. For the Dow Jones, that standard deviation stands at only 1.09% or 60% smaller than that of the HUI.

The distribution is skew to the right. Skewness is highly influenced by exceptional observations at either side. We observe a few exceptional rallies, going back to 2008 and 1999.

Excess kurtosis is also important. This is a measure for the 'peakedness' of a distribution. A high excess kurtosis means that most observations are closer to the mean than for the gaussian (normal) distribution with the same standard deviation, but more importantly: extreme observations are more likely than suggested by a gaussian distribution. This was also observed for the Dow Jones index, where excess kurtosis is even more pronounced. See for comparison: Risk mispricing. 

Confined to -16% to 16% that distribution looks like this:

Figure 1: Distribution of daily percentage variations for the HUI. The blue curve is the equivalent Gaussian distribution having the same mean and standard deviation. Click to enlarge to full screen.

The historic annualized volatility calculated from the above standard deviation is 43.04%. Usually volatiility is calculated as a moving average of the standard deviation of a number of daily variations. Often 21 variations are chosen, averaging the number of stock market sessions in one month. The long-term below chart shows the HUI and its volatility over time.

Figure 2: Long range HUI index (left axis) and its volatility (right axis) since 1996. Data till May 2, 2016 (click to enlarge)

Volatility peaked in 2008 as the HUI index dropped by 60% in a time span of a few weeks. Variations around the turn of the century seem small on an absolute scale, yet the percentage moves during the late gold market bear and the early gold market bull often were of an exceptional nature. There is a rapid succession of volatility peaks during those days. Last year shows a broad, but lower peak in volatility: the plunge of the HUI has been more sustained and gradual than in 2008.

The slide since early September marks another rise in volatility. By mid December 2014, the painful plunge drove volatility beyond the one observed in April 2013, yet the 2008 volatility peak stays completely out of reach. Except for the two first years, the volatility of the HUI index has been relatively high, even during the gold bull market, the annualized volatility never sank far below 20%. The gold miners market is far more nervous than is the broader stock market.

Figure 3 : HUI index (blue, left scale) and its annualized volatility (red, right scale) - Data till May 2, 2016 (click to enlarge)

When limiting observations over the last few years (graph updated), volatility of the HUI index has clearly surged during the April 2013 gold sell-off and it remained at an elevated level even during the summer recovery. On the contrary, the December 2013 precious metals sell-off, causing a new low for the HUI index hardly caused an upward blip in the volatility graph. Moreover, during the May 2014 correction of precious metals, the correction low for the HUI coincides with a volatility trough. This is an extremely unusual coincidence. The normal behaviour resumes in the summer of 2014 as volatility slides in August when the HUI seems consolidating prior gains. Since the September 2014 sell-off, volatility rises reaching 78% by mid December, exceeding the April 2013 peak. Despite gold and miners weakening since February 2015, volatility remained subdued until June. It required the July 2015 continuous slide of precious metals, with gold posting a fresh post 2010 low near $1075 to make the miners break down and send volatility surging again. Miner volatility remained elevated throughout the rest of 2015 and at the onset of the Jan-Mar 2016 gold recovery. During April 2016 the HUI volatility eases. A hefty miner response on gold fluctuations in May 2016 suggest the HUI volatility to be trending up again.

Rallies and Swoons

Table 3: HUI rallies, with ranking, date, magnitude and the volatility at that point in time (data series till Nov 5, 2014).

Ranking	Date	D/D-1	Vol
1	21/11/2008	27.4%	158.7%
2	27/09/1999	24.7%	93.7%
3	08/10/2008	18.7%	114.8%
4	04/02/2000	15.8%	68.1%
5	04/11/2008	14.8%	157.5%
6	28/10/2008	13.9%	147.2%
7	03/09/1998	13.8%	69.3%
8	13/11/2008	13.2%	150.7%
9	29/10/2008	13.0%	156.7%
10	17/09/2008	11.7%	81.3%
11	10/09/1998	11.3%	91.2%
12	04/09/1998	11.1%	79.8%
13	16/05/2001	10.7%	59.5%
14	04/02/2002	10.6%	46.4%
15	20/05/2002	10.5%	53.9%
16	12/09/2008	10.4%	70.0%
17	18/05/2001	10.3%	67.2%
18	24/09/1998	10.2%	101.3%
19	09/05/2001	10.1%	51.7%
20	10/12/2008	10.0%	144.5%
22	18/09/2013	9.6%	54.8%
29	08/08/2013	8.9%	64.2%
42	11/07/2013	7.9%	61.7%
43	07/11/2014	7.9%	59.8%
44	28/06/2013	7.8%	53.8%
53	08/10/2014	7.6%	40.1%

None of the 20 major rallies relate to any of the bear market bounces observed since the downturn in 2013. They are highlighted in red. Nearly all of the rallies occur at high or very high volatility levels, indicating they have been preceded by swoons of a comparable magnitude. Today's 7.9% rally ranks 43 and the previous 7.6% single day bear market bounce on Oct 8 of 2014 is at the bottom of the list, ranking at position 53 of the rallies. 

Table 4: HUI swoons, with ranking, date, magnitude and the volatility at that point in time

Ranking	Date	D/D-1	Vol
1	22/10/2008	-16.3%	129.2%
2	02/10/2008	-16.1%	100.0%
3	01/12/2008	-14.4%	152.7%
4	10/10/2008	-12.7%	124.8%
5	23/07/2002	-12.6%	68.5%
6	07/05/1999	-11.2%	69.5%
7	12/11/2008	-10.9%	146.2%
8	15/10/2008	-10.4%	123.5%
9	10/06/2002	-10.3%	71.5%
10	27/10/2008	-10.1%	134.5%
11	27/10/1997	-9.7%	49.3%
12	06/11/2008	-9.7%	145.3%
13	21/10/2008	-9.7%	119.8%
14	15/04/2013	-9.4%	49.4%
15	09/10/1998	-9.2%	79.9%
16	09/09/2008	-9.2%	64.1%
17	16/10/2008	-9.2%	118.2%
18	26/07/2002	-9.1%	78.4%
19	28/04/2004	-8.6%	43.3%
20	07/01/2009	-8.1%	71.6%
23	22/09/2011	-7.7%	38.5%
27	20/06/2013	-7.5%	46.9%
29	30/10/2014	-7.4%	51.2%
45	20/09/2013	-6.3%	56.0%
53	26/06/2013	-6.1%	51.9%
57	06/08/2013	-6.0%	56.7%
58	12/04/2013	-6.0%	39.5%

The major 20 swoons include the 9.4% drop mid April 2013 as gold broke below its long established support of $1560/Oz. As for the rest of the swoons of the 2013-2014 bear market, we find most of them at the bottom for the list. They rank from position 27 to 58. On position 23 is the 7.7% drop shortly after gold slid off its all time high in September 2011.

It is indicative that major rallies and swoons both occur during miner bear markets or severe corrections. Bull markets typically progress through more frequent and smaller gains outnumbering the occasional minor losses. Volatility generally fades to low levels during miner bull markets.

The HUI and the gold price since 2006

Since the early gold bull years, the HUI index used to quote at about half the value of the gold price in USD/Oz. That measure has long been indicative for setting up trades between the two related asset classes. The ratio brutally broke down in 2008. After the financial crisis, gold miners attempted to catch up with the rising gold price, but did not reach their pre-crisis relative valuation level. As gold continued its rise towards the August 2011 top, gold miners were lagging. They peaked barely above the level of November 2010, when gold reached $1400/Oz for the first time.

HUI (blue on the left scale) and gold in USD/Oz, dark red on the right scale. Data till May 29, 2015 (click to enlarge)

Now we are further away than ever from the 2:1 ratio of the early gold bull years. HUI/Gold plunged below the level observed in 2000, before the onset of the gold bull. The absolute level of the HUI index now is beneath its trough of 2008, when gold quoted near $700/Oz.

Hoping for a return to the 2:1 ratio is an illusion. Bad management decisions in a good number of major gold miners result in a permanent impairment. Reckless acquisitions, diluting shareholders to buy back under-water hedge positions dating back to the 20th century are only two of the many reasons why we won't see the 2003-2007 valuations any more. However, the present valuation of the HUI has dropped to the other extreme. Even halving the gap from 8:1 to 4:1 would imply the HUI doubling relative to gold. We probably won't even need a return of gold prices near their all-time-high to achieve this.

How it went from bad to worse has been pointed out in several prior postings:

1. Miners relative to precious metal prices: a tactical approach (July 2012)
2. Miners relative to precious metal prices: an update (January 2013)
3. Anatomy of a gold miner bear market (December 2013)
4. Three year slide for precious metal miners (December 2014)

There also is a recurrent topic on the ‘GoldMinerPulse’ blog page, which is refreshed weekly. Note: The latest updated long term graphs of HUI/Gold can be found at HUI mining index relative to gold.

Since gold broke below its resistance level back in April 2013, junior miners and explorers were beaten up, leaving investors with a couple of dimes on the dollar… if not worse.

Several large cap miners may stomach lower gold prices for a while longer. They have several production sites, some of which may be marginal but others still can earn a decent profit, even at current low gold prices ($1.145/Oz while drafting this article).