Gold miners regain their regression trend line

Since the summer of 2018, the HUI gold miners index has been following a regression trend line relative to gold. The emerging trend was first described in September 2019 and confirmed last year.

Trend challenges

The regression trend line has been challenged twice. The Corona dip mid March 2020 impacted miners much more profoundly than it did the yellow metal. The digression from the trend line proved to be temporary. Miners recovered swiftly and were above trend as the yellow metal steamed up to its 2011 all-time high. Enthusiasm waned as gold was peaking above $2000/Oz. This has been described in more detail in the September 2020 article: Miners (HUI) to gold linear regression still intact.

During the subsequent saw-tooth correction, miners once more sank below their regression trend line. Undervaluation bottomed out by in February, despite gold fluctuating around $1800/Oz by that time. Miners withstood well the initial gold correction early March. Only as the metal slid below $1700/Oz, gold miners plunged well below their regression trend line again. That occurred on two occasions: around March 8 and around March 30. As the correction of the yellow metal seems to have bottomed out, miners are looking up again and recover from a lengthy down trend.

Synoptic view of Gold (red graph) on the left axis and the HUI (blue graph, read on the right axis) - click to enlarge to full scale

In the 'synoptic view' graph, the HUI/Gold regression has been implicitly made use of. The red graph both represents the gold price, when read on the left axis, and the regression value of the HUI miners index, when read on the right axis. The blue graph provides the true HUI values, which should fluctuate around the regression values for the regression to hold.

As the true dimensions of the Corona outbreak had become obvious, a first digression suddenly emerged, with miners plunging deep, while the gold correction was more shallow and temporary. The recent digression has been smeared out over time, but manifested itself with miners ignoring gold strength during February and subsequently succumbing feverishly to a double dip gold correction in March. Only recently miners have regained their regression value.

Regression residuals

Regression residuals are the differences pattern between true HUI values and their 'expected' regression values. These residuals are shown in the graph below.

Regression residuals since June 2020 (click to enlarge)

After the initial gold recovery in May 2020, miners weaken again. There is uncertainty on the COVID impact on mining operations. During the gold rally, miners take the front-seat in July. However they weaken relatively as gold peaks above $2000/Oz early August 2020.  Positive residuals make way for negative ones early November.  Miners gradually sink deeper below the trend line. Towards end February, the worst seems over but the nascent miner recovery is thwarted twice by gold sliding below $1700/Oz in March. Only after Easter, gold miners regain the trend line, with small positive residuals now showing up.

Hui - Gold Regression trends

Regression trends can be derived by plotting (HUI, Gold) couples on a graph. 'Time' is thereby eliminated. As shown in the below graph, a regression is a statistical tendency lasting over a medium to longer time frame. It is not a mathematical axiom or physical law carved in stone. 

HUI - Gold regression lines

The top line shows the regression relationship that was valid between summer 2012 and autumn 2017. It guided us through the gold bear market and the 2016 boom/bust cycle only to give way later on as miners were unable to match any timid gold recovery. Systematic and increasing negative residuals eventually invalidate a regression trend.

The current regression line 'predicts' much lower HUI index values for any given gold price than the former regression did. This should remind mining investors that 'leverage to the gold price' (often called 'optionality') generally holds over a short to medium time frame, but definitely not over decades.

Miners lagging gold over the very long term 

Miners are poor investments as compared to gold over the very long term. This is well illustrated by these 'secular' graphs showing the HUI index and gold since 1996.

Gold (red, left axis) and HUI gold miners index (blue, right axis) since 1996
(click to enlarge)

Both axes start at zero, with the scales implying a HUI/Gold ratio of 0.40. During much of the gold bull market after 2001, the HUI index posted well above 40% of the USD gold price. After the 2008-09 financial crisis, the curves seem to match well, but the miners can't catch up with gold in 2011. Despite gold close to three times more expensive than in 1996, even at the depth of the 2012-2015 bear market, the HUI miners index actually bottoms well below its 200 initial value.

'Optionality' definitely is a sell-side analysts' argument. It sounds as one of those fancy concepts designed to lure less informed investors into jumping on the bandwagon of an ongoing miner bull market. 

Moreover, the Hui gaining about 50% over 25 years is but a bleak accomplishment when compared to any broad US stock market index, which all have risen to a high multiple of their value a quarter of a century ago.

HUI/Gold index

Since the HUI/Gold ratio is a good measure to illustrate gold miner performance over time, following graph also is illustrative:

Gold bullion price (red, left axis) and HUI/Gold ratio (dark, right axis)

At the recent all time high, the HUI/Gold ratio didn't even match the value it attained at the top of the 2016 boom/bust cycle. Values up to 0.5 for HUI/Gold ratio were not uncommon during the 2001-08 gold bull market. Those definitely are past perfect.

Final thoughts

As an asset class gold miners definitely are poor long term investments. Necessarily such also is the case for broad mining ETF's such as GDX and GDXJ. Since the performance disparity is extremely high, few miners may excel over time. Notably several precious metal royalty and streaming companies have outperformed most miners over the long term.