Friday 22 May 2020

Revival of gold mines - Corona dip overcome

Gold mining investors were shaken as stock markets tanked and subsequently precious metals dipped at the outbreak of the Corona pandemic: miners suffered a double whammy. The recovery last two months has been vigorous, with tailwinds from both a gold price rally and the (FED) liquidity driven selective stock market recovery.

HUI index

The HUI index of unhedged gold mines is a widely used benchmark index for major gold mines. It has been around since 1996. The impact of the Corona pandemic is best illustrated on a 6 months graph with daily observations (

HUI gold mining index - Daily observations over 6 months. (click to enlarge)
Not only the HUI index has recovered from its mid March dip, it resumed its uptrend in place since gold broke above its trading range last summer. Only claiming that the Corona dip has been overcome is an understatement: gold mines are reviving.
But to what extent? Do miners now rise in lockstep with the gold price? Are they leveraging up the gold price rise? An answer is given when evaluating how the stocks from the HUI index resume the regression relationship put in place since mid summer 2018.

HUI to Gold regression

Price trends of individual miners are correlated with the gold price. On an aggregated level, a linear regression between the HUI gold miners index and gold may for hold several years.

In order to derive a linear trend between two time dependent variables, it is necessary to eliminate time, retaining only the couples of variables. Here (HUI, Gold) couples are retained, whereby the gold price on the horizontal axis is used to 'explain' the aggregate price level of miners as revealed by the HUI index.

Linear Regression Trends between gold and the HUI miners index - (click to enlarge)
This procedure was first applied to the HUI-Gold price trend prevailing from about mid July 2012 till late summer 2017, when it started degrading. In the below graph these are the blue dots, with the red regression line. After the summer of 2017, miners systematically were dropping below the regression line. The mismatch aggravated with miners moving sideways as gold was progressing reaching the top of its trading range around $1350/Oz. During spring 2018, gold repeatedly topped above $1350/Oz, yet miners ignored gold strength and slid lower. Corresponding points are the light blue dots in between the two regression lines.
Candidly however, major gold miners were coupling to the gold price again, though at a much less challenging pace. 
This regression procedure minimizes the sum of squared differences of the dots (observed values) to the regression line. Brown dots and the black regression line show the new linear behaviour relating the HUI to gold:

HUI = 0.2608 . ($Gold - $ 674.9)   (correlation 0.9)

Corona impact

Parameter creep is but one of the impacts of the Corona dip. The slope has weakened, though only on the third decimal, while the gold price intercept was tuned down by about $6. The correlation suffered a setback to 0.90 from 0.95.
In the above regression graph the Corona impact is the 'belly' of isolated points below the regression line, extending from below $1500 to over $1700. In order to pinpoint this in time, we can just have a glance at the HUI/gold ratio graph of the last 6 months:

HUI/Gold ratio - Daily observations over 6 months - (click to enlarge)
An initial late February dip still is overcome early March. However, even before gold peaks on March 9, broad stock markets sell off, entailing a slide of miners. That slide is aggravated as precious metals dip. Such phenomenon is not uncommon during a major market plunge, when derivative losses need to be covered. Gold mining stocks cratering ends on March 16, with the HUI/Gold ratio touching down to 0.10, a level last seen by the end of the 2012-15 gold miner bear market.

Synoptic graph

Knowing the regression line, a synoptic view can be made using two different Y-axis. The left one is for gold, while the right axis for the HUI is modified to implicitly reflect the regression relationship.
As such the red curve for gold on the left axis coincides with the regression value for the HUI when read on the right axis. The blue curve are the observed HUI values equally read on the right axis.

Synoptic graph of  gold (left hand scale) in red and the HUI (right hand scale) in blue (click to enlarge)
Also on this graph the Corona impact manifests itself as an amplified plunge of the HUI relative to that of gold. Yet the (blue) line of the HUI index again has caught up with the gold price. Lately the residuals turned positive again: the HUI to gold regression is scarred but not slain.


The residuals are the 'matching errors' between the regression line and the observed values. Those residuals are the tell-tale for validity of any regression. Residuals need changing sign from time to time as undervaluation of miners changes to overvaluation and vice-versa. 

Residuals between the regression values and the observed HUI values (click to enlarge)
This graph best shows the impact of the miner sell-off at the Corona dip and their subsequent recovery.


With the HUI index back at (and above) its regression value, is there a decent chance for miners outperforming the metal significantly?  Well, they have during the recovery after the Corona dip. From an intraday bottom below 145 on March 16 the HUI index doubled, having peaked above 303 intraday on May 20. Meanwhile, gold added less than $300 or under 20% from its dip to the recent Comex close at $1748.5.
On the regression line, miners are outperforming gold only little.
You may have estimated what the HUI/Gold ratio looks like with the present regression relationship:

HUI/Gold = slope . (1 - intercept / Gold) = 0.2608 . (1 - $674.9 / $Gold)

That implies that HUI/Gold is limited to the slope value (0.2608) as gold keeps rising.  The HUI index outperforming gold is quantified: the ratio HUI/Gold keeps rising with the gold price, since the negative term gets smaller due to the gold price in the denominator. If you expect anything more substantial, that would require the the HUI-Gold regression relationship to break to the upside with higher gold prices and HUI values over a longer time frame. Such event definitely would be unprecedented.

It is pretty safe to assume that HUI/Gold never will be nearing 0.40 again, though that used to be the bottom of a trading range prevailing during the initial Dec 2001- Mar 2008 gold bull market. Kitco daily publishes the inverse ratio Gold/HUI on its website. It would be a miracle to see Gold/HUI below 2.5 again, while I firmly believe Gold/HUI won't ever touch down to 3 either. Gold/HUI dropping to 4 is about all what the current regression relation deems possible. Optimism is somewhat mitigated on the aggregate performance of major gold miners. More significantly outperforming gold only is possible by suitable miner stock picks (not necessarily major miners), yet that's a completely different story.

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