Monday, 12 February 2018

Gold miners persistently lagging the metal

The latest downturn of gold brought the yellow metal to a Friday close of $1315.7, easing barely 1.22% over the week and still holding on to a tiny advance year-to-date.
However the HUI plunged 7.17% leveraging gold down sixfold. While miners had been persistently lagging the metals throughout 2017, their decline currently is aggravating.

Very seldom in my blogging career an article has been so ominous as the 'Persistently lagging the metals' posted last year on Oct 29. Whatever well paid sell-side analysts may want you to believe, the gold mining sector is not the place to be. It may reward you during the short stretches up, but you may end up penniless over the long haul. Not surprisingly the HUI/Gold ratio dropped to 0.1327 on Friday Feb 9, a two-year low (since shortly after the onset of the gold miner recovery early 2016).

Though gold ($1158/Oz) was way below the current level as trading started on Jan 3, 2017, HUI/Gold posted at 0.164. Even in absolute index points HUI closed at 189.9 on the first trading day of 2017. Meanwhile HUI is down to 174.5, though the yellow metal added about $160 in little over a year. 

During 2017 gold successfully tested its $1200 support as the metal retreated after an initial recovery from the Dec 2016 low. The graph below, covering 9 months, illustrates the gradual improvement of the gold market, with progressively higher lows and the January 2018 top also breaking above the 2017 high. 

Gold  Price (spot): daily observations since early May 2017
The graph ends at the Feb 9, 2018 close at $1315.7. Most of the 2018 advance was lost, yet gold ended 2017 rallying to $1302.5. Whereas the July swoon went below $1210 intraday, last December trough bottom was around $1240. The situation is fundamentally different for gold miners: you find the HUI index covering the same period below:

HUI 'unhedged' gold miners index:  daily observations since early May 2017
Now follows the HUI/Gold ratio graph. The gold miner pulse page shows the current situation over a six months perspective.  Extending the focus to 9 months as before, the below graph is illustrating the progressive deterioration of the gold mining sector.

HUI/Gold ratio:  daily observations since early May 2017 
At 0.1327, HUI/Gold is back to its level on Feb 22 of 2016, when gold quoted at $1225.4.  By June 24, 2016 Gold had rallied to its current level with the HUI posting at 237.9 and HUI/Gold at 0.1808. This illustrates well the deterioration gold miners suffered since the first gold recovery after the four year bear market.  Yet this downturn is relatively recent. For most of the gold bear market, the complete 2016 recovery and its breakdown and even the onset of the 2017 recovery, HUI correlated well with gold. An excellent regression line predicted where the HUI was expected at the actual gold price.
Gold -HUI spread and regression trend line.
  • Yellow dots (top right) cover the period leading towards the Aug 2011 all time high and shortly after, when the HUI failed to catch up with the rising gold price.
  • Blue dots correspond to the lump part of the gold bear market (from summer 2012), throughout the 2016 boom-bust and into the 2017 recovery until early August 2017. They obey well the regression relationship.
  • The red dots correspond to recent observations, systematically below the regression line and deteriorating progressively as will be shown.

A regression line tells you the linear relationship between a 'dependent variable' (here HUI) and the independent causal variable (here Gold price in USD). This has been described in a couple of articles, notably the latest "Linear Regression between the Gold Price and the HUI miners index"

Using the slope and intercept calculated from the regression line, a synoptic view of the HUI and gold can be drawn, using a different Y-axis for both but reflecting the regression parameters. The above publication demonstrates how it marvellously upholds during five years. 

The below chapter and graph illustrates how it now miserably breaks down since last summer.

HUI - Gold synoptic view

Similar to the linear regression between the HUI and Gold over the long haul, we repeat this procedure for the year 2017.  Gold miners persistently lagging the metal as claimed in the title implies that the linear regression fails over the short time stretch. You can check in the below graph, with fresh data till March 26 only corroborating the ongoing trend.

Gold ( red graph, left scale) and HUI (blue graph, right scale) since Dec 15, 2016
Graph updated on March 26
Parameters for the short term linear regression are calculated using data since Jan 2017 only. 

The regression line responds to HUI = 0.668 * ($Gold - $969)

However at 0.12 the regression coefficient is extremely poor.  Not surprisingly: The gold price trends upward over the year, yet the HUI gold miners index is moving sideways. No regression-line can reliably reflect such non-linear event. Both graphs are starting on Dec 15, 2016. Gold bottomed on that day. The yellow metal had been selling off after peaking over $1350 in July. Miners again post lower as the metal peaked above its July 2017 high in January 2018. The recent pull back of the gold price is only widening the gap.

The present situation reflects that of 2011 when gold miners failed to catch up with the gold price as it accelerated to the August all time high.  We need to carefully monitor the regression relationship in order to confirm that it indeed has broken down or has been shifting to different parameter values, thereby invalidating the relationship that guided us throughout the gold bear market and the 2016 boom/bust cycle.

Mid term view

Table 1: Gold and the HUI on Feb 9, 2018 and where they are compared to their Dec 2016 swoon lows and 2017-18 rally highs.

 oN feb 9
Up from low
Down from High

Gold recovered well from its mid Dec 2016 low, while the HUI lags about 10%.  Moreover, gold currently is down only 3.1% since its recent rally high, whereas the HUI shed over a 21%.  Highs and lows are closing values, no intraday peaks or plunges.

What is at hand in gold mining ?

As a result of the gold mining bear market, gold producers were forced to downgrade some of their reserves to the 'measured and indicated resources category'.  Those resources can no longer be mined at the current gold price.  As richer or more easily accessible ore layers are being depleted first, miners are more rapidly exhausting their high margin deposits.
This policy is well known as 'high grading'.  It may allow miners to bridge short periods of subdued gold prices, however at the cost of hampering future profitability.

The first consequence is gold output declining and miners missing at the top-line when the gold price assumes its uptrend.  There is no easy way out: buying high margin resources and building a new mine usually dilutes share holders.  Converting measured and indicated resources back to proven and probable reserves is another option. This requires new investments in mine construction or extension. It allows expanding production without prior acquisitions, however at higher all-in sustaining costs:  yet another challenge for profitability.


Investment strategy differs from tactics.  The former may guide you in capital allocation to the economic sectors which should outperform over the coming decades.  The latter tells you which equity currently has an excellent recovery potential or which may rally, given that likely success in ongoing projects is not anticipated on.

Investment strategy should guide you away from the gold mining industry.  Tactics may lure you into it, hoping for short term gains.  A gold price rally will make gold mining equity outperform.  Yet this is no structural recovery.  Gold mines may continue lagging the metal throughout the ebbing and flowing of the ongoing up-trend of the yellow metal. 

If past experience provides any valid guideline:  Gold mining equity has been lagging the gold price ascent from the second half of 2010 onward, throughout the gold rally to its ATH and during the initial phase of the bear market till summer 2012. This doesn't bode well for the near future.

Prior articles on this topic:

1 comment: