When an investor buys stocks, they do so in anticipation of the underlying company or asset performing well into the future, thus allowing the investor to make a profit on the dollars allocated to it. Stocks are supposed to be a leading indicator of how well a company will do.
In deciding on whether to buy a stock, there are many things to consider including management of the company, sales, profit margin, how much cash is on hand and how much debt is held relative to equity, among other considerations.
Investing in Gold Mining Companies
When investing in gold mining companies, there is one other benefit or detriment depending on one’s timing, and that is the amount of gold ounces the company you invest in has on hand.
While investors will speculate on gold mining companies ability to produce more gold based on the productivity of the mines they operate, there is a way for an investor to profit when the company does nothing but normal business activities. This hidden profit in gold (and silver) mining companies comes from the number of ounces of the metal they currently have on hand.
Investors buy these gold mining companies in anticipation of these ounces held going higher higher in price. Of course, the ounces held could go lower in price too, thus negatively affecting the price of the stock.
This is what occurred during the market crash of 2008 where both the S&P and gold mining stocks got hammered as seen in the following chart.
For awhile in 2008, the price of gold got hammered too, but gold ended the year positive going from $838 at the end of 2007 to $885.50 by the end of 2008, a 5.4% increase in price.
Now that gold has broke to a new high in 2010, just north of $1,260, it has been struggling the past month to break out even further. Even the July move to an all-time high wasn’t much of an improvement over the November 2009 high.
The HUI Index, otherwise known as the Gold Bugs Index, hasn’t been as exciting as gold of late. In fact, the stocks that represent the HUI Index are well off their 52 week highs. Before getting into that analysis, for those who are not aware of what the HUI Index is, the next section will help.
What Is the HUI Index?
So what exactly is the HUI Index? From the NYSE:
The NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI) is a modified equal dollar weighted index of companies involved in gold mining. The HUI Index was designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years. The HUI Index was developed was a base value of 200.00 as of March 15, 1996. Adjustments are made quarterly after the close of trading on the third Friday of March, June, September & December so that each component stock represents its assigned weight in the index.
Companies that hedge their gold holdings want to protect them from losing value during any potential decline in the price of gold. They will buy put options so if the price of gold falls, they potentially won’t lose any net value on their hoard of gold.
Companies that have bought put options in the past 10 years have lost what they paid for them. They have subsequently learned to unwind their hedges as the price of gold has moved higher each of those 10 years. Perhaps some may be hedging again. It’s important to know these things before investing in a company. Sticking with those that make up the HUI Index alleviates this concern as they are restricted as to how much hedging they can do.
The companies that make up the HUI Index at present, as well as the percentage of the index they represent can be seen in the following chart.
Back to the HUI Performance
While Gold broke to new highs in November of 2009 and June of 2010, the HUI has not broken the high set in May of 2008 of 514.89. It came close on December 2, 2009 when it hit 510.58, but is still struggling today to lead gold higher as a predictor of what is to come.
The Elliot Wave theorists would like to tell you a fall in the HUI is coming, as well as gold as the following charts show, compliments of Ron Rosen (click charts for better view).
The interesting aspect to the price of gold to me is that it was moving higher during its run up in price, despite the fact the Dollar Index was at the same time moving higher, bucking the trend of the last 10 years. This is an important juncture in analyzing the price movement of gold.
The last two days have seen some buying of gold come in again, even with the Dollar Index moving higher as seen in the following two tables.
August 11
This diversion we’ve been experiencing with both gold and the dollar moving higher is because of the perceived flight to safety that was occurring during the Greek and other PIIGS crisis that was developing which negatively affected the Euro.
But does the U.S. dollar represent safety? For now, it still does as over 70% of the world still transacts business in U.S. dollars. Naturally, with all the government spending occurring, this trend will reverse. “When” is the only question left to be answered.
The fact of the matter is however, gold has appreciated versus all currencies to the tune of over 140% in the past 10 years. Comparing the U.S. dollar to other weak currencies can be a recipe for disaster in protecting one’s portfolio.
Elliott Wave Issues
I’ve written before on the problem with Elliott Wave Theory. It simply doesn’t take into account external influences which can alter the course of things and cause the Elliott folks to draw new lines and make different conclusions. In a perfect world, they can be right.
The Bottom Line For Investors In Gold
The HUI went from its high of 514.89 in March of 2008 to a low of 151.37 by October 27, 2008, a 70% drop. Physical gold finished the year 2008 positive. Holders of physical gold care not that if falls to $900 or so on its way to $2,000 and higher.
While I am in the deflation camp and have written several articles stating the case for current deflation, with monetary inflation occurring at the same time, one must remember that gold has appreciated over 160% against the Japanese Yen the last 10 years. In other words, despite Japan’s decade plus struggle with deflation, gold has appreciated over 160% against the Yen the last 10 years.
How many of you would take that return for the next 10 years? Dollar cost averaging into a physical gold and silver position makes sense at present, hoping the price goes lower so you can secure an overall better price. Naturally the price will move much higher from current levels. You can bank on that!
For traders invested in gold mining stocks, or thinking of buying them, barring any external influences, I’d be cautious at present. I’d like to see the 515 mark taken out on the HUI before going long.
If one follows Dow Theory, they can take the same concept and apply it to the U.S. dollar price of gold and the HUI. Without one confirming the other, in this case, the HUI confirming the U.S. dollar price of gold highs, it’s best to be careful with any trading long the HUI at present….barring any external influences (which external influences among other concerns is why physical gold should be the base of one’s portfolio).
What is a guy who sells gold and silver bullion doing telling people to be cautious?
I’m not your typical “gold bug” where every other word out of my mouth is that of chicken little screaming “hyperinflation, hyperinflation!” I do recommend everyone hedge their U.S. dollar portion of their portfolios against the risk associated with the U.S. dollar by owning physical gold and silver.
As I said before, dollar cost averaging into a position at any time, makes sense.
The rest of my analysis just gives the trader food for thought. They are my opinions based on my own research and those opinions are not meant as investment advice.
I’m not out to prove anything except that there is a flaw in the financial services industry I was a part of for over 20 years. That flaw is the belief the U.S. dollar is a “risk free” asset. I offer solutions to that flaw; physical bullion gold and silver.
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About Doug EberhardtDoug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534
Disclosure:
Commodity Futures Trading Commission Futures and Options trading has large potential rewards, but also large potential risk. You must be aware of the risks and be willing to accept them in order to invest in the futures and options markets. Don’t trade with capital you can’t afford to lose. This is neither a solicitation nor an offer to Purchase/Sell futures or options. No representation is being made that any account will or is likely to achieve gains or losses similar to those discussed in this outlook. The past track record of any trading system or methodology is not necessarily indicative of future results.
All trades, patterns, charts, systems, etc. discussed in this outlook and the product materials are for illustrative purposes only and not to be construed as specific advisory recommendations. All ideas and material presented are entirely those of the author.