Tag Archives: gold mining

Spotlight on the HUI and XAU Gold Stock Indexes

Probably the two best known gold mining stock indexes in the world’s financial markets are the HUI and the XAU. HUI is the ticker symbol for the NYSE Arca Gold BUGS Index. XAU is the ticker symbol for the Philadelphia Gold and Silver Index. Both of these monikers make an appearance on many gold related websites and many general financial market websites as well, so its worth knowing briefly what these indexes are and what they represent.

A quick note on terminology: The words indexes and indices are equally correct, it just depends on your preference. Likewise, when talking about gold stocks within indexes, we can interchangeably use the terms gold stocks, gold mining companies, gold miners, equities, securities, index components, index constituents etc.

NYSE Arca Gold BUGS Index (HUI)

The HUI was launched on 15 March 1996 by the American Stock Exchange (AMEX), and was originally known as the AMEX Gold BUGS Index. BUGS is an acronym for ‘Basket of Unhedged Gold Stocks’. Through a process of various stock exchange mergers and acquisitions over time, the HUI is now known as the NYSE Arca Gold BUGS Index.

Briefly, in 2008, the AMEX was acquired by NYSE Euronext. In 2006, NYSE had acquired the Archipelago (Arca) trading platform. Hence, as a result of these acquisitions and exchange mergers, the NYSE changed the name of the AMEX Gold BUGS Index to the NYSE Arca Gold BUGS Index. An archived imprint of the AMEX website from 1996 can be seen here.

Also note that in 2012, Intercontinental Exchange (ICE) acquired NYSE Euronext, so the NYSE Arca is now owned by ICE and the Gold BUGS Index is now calculated by ICE. The letters in the ticker HUI do not mean anything, i.e. H, U, I is not an acronym or a shortened version of anything. If anyone thinks HUI might signify something of relevance, please add a comment below this article.

According to the official ICE methodology document, the HUI is “designed to measure the performance of companies involved in the mining of gold ore“. It specifically only includes stocks of companies that do not hedge their gold production beyond one and a half years. By including only non-hedging gold miners, the index therefore attempts to provide exposure to near term gold price movements.

Another distinguishing characteristics of the HUI Index is that its a modified equal weighted index of gold mining stocks. A modification means that companies in the index are weighted to an extent but not fully. The process works as follows. All eligible stocks are ranked based on their full market capitalization (and not their free float). The top two stocks are each attributed a 15% weight. The third ranked stock is attributed a 10% weight. All remaining stocks from fourth position down are equally weighted into the remaining 60% of the index weight. Generally speaking, the free float is that portion of the outstanding equity that is not held by insiders.

HUI – NYSE Arca Gold BUGS Index, 5 year chart. Source: www.GoldChartsRUs.com

Many websites all over the internet state that the HUI is equally weighted, but this is not correct as they fail to mention the above modification. For those interested in the HUI methodology, you can read the methodology document here.

Gold mining stocks eligible for inclusion in the HUI have to be either listed on the NYSE or the ‘NYSE American’ or else traded on NASDAQ. NYSE American is a small cap exchange operated by NYSE  and was formerly called NYSE MKT, and is inherited from the American Stock Exchange (AMEX). The number of gold mining stocks that can be included in the HUI is variable and the constituents can change quarterly during index rebalances. When launched in March 1996, the HUI had a base level of 200.00.

HUI Components

The HUI currently has 23 constituent securities predominantly companies headquartered in the US, Canada and South Africa, including the large Goldcorp, Newmont Mining and Barrick, and miners such as Eldorado Gold, Kinross Gold, and Tahoe Resources. It also includes the American Depository Receipts (ADRs) of the South African miners, AngloGold Ashanti, Randgold Resources and Sibanye. The HUI also includes the predominantly silver miners Coeur Mining and Hecla Mining. A full list of the 23 components of the HUI can be seen here.

Fourteen of the gold miners in the HUI are also members of the World Gold Council. With 24 gold mining companies currently members of the WGC, this means that 10 WGC members are not represented in the HUI, which can be put down to those companies not having a listing on a US securities exchange, and perhaps being excluded for other reasons such as hedging their production. Some gold miners in the HUI are not members of the WGC for various reasons, such as they left the WGC, e.g. Gold Fields, or they are more naturally members of the Silver Institute, such as Coeur and Hecla.

GDM and JHUI

The NYSE also operates two other gold mining indices of relevance. These indexes are less well-known than the HUI and are the NYSE Arca Gold Miners Index (GDM), and the NYSE Arca Junior Gold BUGS Index (JHUI).

Unlike the equally weighted HUI, the NYSE Arca Gold Miners Index (GDM) is a market capitalization weighted index that comprises ‘publicly traded companies primarily involved in the mining of gold and silver in locations around the world.‘  This broader representation of gold and silver mining companies from around the world (instead of just a US listing), and the fact that inclusion is not limited to miners who don’t engage in hedging, explains why there are currently 49 components in the GDM, a list of which can be seen here.

Nearly all the WGC members are present in the GDM. There are also a lot of Australian gold mining companies in the GDM, and a couple of Chinese gold mining companies in the index, namely Zhaojin Mining Industry and Zijin Mining Group, but no Russian gold miners (maybe due to political reasons). The number of stocks that can be included in the GDM is also variable and the constituents can also change quarterly during index rebalances. The GDM was launched in October 2004. Anyone interested in the GDM index methodology can read its methodology document here.

The NYSE Arca Junior Gold BUGS Index (JHUI) is a modified equal weighted index of small-cap companies involved in gold mining. With a similar index creation process to the HUI, the JHUI methodology document can be seen here.

Philadelphia Gold and Silver Index (XAU)

The Philadelphia Gold and Silver Index (XAU) is a modified market capitalization weighted index of the stocks of companies active in gold and silver mining industry. The XAU was launched in January 1979 with a base value of 100.00. Like the HUI, the XAU is now part of a bigger exchange group, in this case part of NASDAQ OMX. This follows the merger of NASDAQ and OMX in 2007 and their acquisition of the Philadelphia Stock Exchange, America’s oldest exchange, also in 2007. An archived version of the Philadelphia Stock Exchange website which mentions the XAU can be seen here.

To be eligible for inclusion in the XAU, a security of a gold or silver miner has to be listed on either the NYSE or NYSE American exchanges, or else traded on NASDAQ. The company also has to have a market cap of at least US $100 million and meet a certain liquidity threshold of at least 1.5 shares traded in the last 6 months. Importantly, the XAU does not make gold hedging an exclusion criterion, therefore the XAU can include miners that hedge their production.

XAU – Philadelphia Gold and Silver Index, 5 year chart. Source:  www.GoldChartsRUs.com 

A number of parameters are applied to the XAU to prevent various large cap gold miners dominating the index weights. These parameters include that no stock can have a weight greater than 30% of the index, and that the top 3 stocks by market cap together do not represent more than 60% of the index’s weight. The XAU is rebalanced quarterly at which points a company can be ejected or added based on various eligibility criteria. The methodology document of the XAU can be seen here.

There are 30 gold and silver mining stocks in the XAU. A list of component stocks can he seen on the NASDAQ site here and a list with live prices on the Investing.com website here. The XAU contains a lot of the same mining companies as the HUI such as Barrick, Goldcorp, Newmont and Kinross, but some other names besides, such as Pan American Silver, First Majestic Silver, McEwen Mining, and Sandstorm Gold. With 30 stocks in the XAU, it takes in most of the members of the 24 member World Gold Council.

VanEck Vectors Gold Miners ETF (GDX)

Another gold stock ‘metric’ which is often seen on precious metals websites is the GDX. This however is not an index but an Exchange Traded Fund (ETF), namely the VanEck Vectors Gold Miners ETF (GDX). The GDX tracks the above mentioned NYSE Arca Gold Miners Index (GDM).

There is also a VanEck Vectors Junior Gold Miners ETF (GDXJ) which tracks not the JHUI but the MVIS Global Junior Gold Miners Index. The below chart shows the performance of the GDX vs the GDXJ. Notably, from January 2010 to September 2017, a time period during which the US dollar gold price fell by 20%, the GDX returned a negative 45%, highlighting the under-performance of gold mining stocks to the gold price during this period.

GDX – VanEck Vectors Gold Miners ETF, 10 Years. Source: https://www.bullionstar.com/charts/

Beyond the HUI and XAU, there are many more gold mining indexes around the world, some of them global in nature, such as the S&P/TSX Global Gold Index and the NASDAQ OMX Global Gold & Precious Metals Index, and some that are exchange specific such as the Johannesburg Stock Exchange (JSE) Gold Mining Index. But the HUI and XAU are arguably the best known.

S&P/TSX Global Gold Index, 5 Year Chart, Source:  www.GoldChartsRUs.com

Gold Mining Equities – Not the Same as Physical Gold

Investing in gold mining stocks or funds that track equity-based gold mining indexes is very different to investing and holding physical gold bars or gold coins. The stock, or common equity, of a gold mining company, is a from of ownership of that company, and comes with a risk profile very different to that of physical gold ownership. This includes stock specific risk, sectoral risk of the gold mining sector, and general equity risk connected to the equity markets.

Because these companies are generally involved in exploration and production, gold mining stocks also introduce operational risk, management risk, risks associated with corporate governance, risks associated with hedging the gold price (or not hedging the gold price), and political risk associated with the countries in which a company’s gold mining assets are located. It is precisely because of gold mining company mismanagement that there is currently an initiative underway to launch a Shareholders Gold Council of institutional buy side money to address this corporate mismanagement.

Gold mining stocks do provide a form of exposure to the gold price, and usually a leveraged one, therefore the price movements of gold mining stocks are more volatile than the gold price, both on the upside and downside.

The same is true of funds or ETFs which aim to track gold mining indexes such as HUI or GDM, albeit that a diversified portfolio of gold mining stocks that a fund holds will diversify across company specific risk, but not gold mining sectoral risk or broader equity market risk and stockmarket / exchange risk.

Gold Price vs HUI 5 Year Chart. Source:  www.GoldChartsRUs.com

As it only includes mining companies that do not employ hedging, the HUI has a higher correlation with the spot gold price than the XAU. But neither the HUI nor the XAU track the gold price as can be seen from looking at the variability of the Gold / HUI ratio and the Gold / XAU ratio.

XAU vs Gold 5 Year Chart. Source:  www.GoldChartsRUs.com

Investors can hold both physical gold and gold mining stocks and funds, Its just important to remember that they are different things, and different asset classes. Gold mining stocks are risk securities issued by corporations that trade on stock exchanges. Physical gold is a tangible asset with no counterparty risk or default risk. Physical gold exists in limited supply and cannot be created, nor can it be issued by governments or monetary authorities.

The Shareholders Gold Council (SGC) – “Just don’t mention the Gold Price”

One of the more interesting developments in the gold mining sector at the moment is the impending launch of an investor alliance called the Shareholders Gold Council (SGC) whose objectives focus on reversing the poor shareholder returns and underperformance that has been dogging the sector’s leading gold mining stocks for some time now.

This new ‘Council’, which will be activist in nature, has been spearheaded by well-known hedge fund Paulson & Co, and was first pitched to fellow institutional investors and hedge funds during a Paulson & Co presentation at the Denver Gold Forum in September 2017.

For those unfamiliar with Paulson & Co, this is a hedge fund firm established by John Paulson in 1994. Paulson’s hedge fund firm rose to prominence in the late 2000s when it shorted subprime mortgages, and correctly bet on the collapse of the US housing market. Paulson & Co pursues event-driven strategies including merger arbitrage and corporate restructurings and runs a number of funds across equities and credit. Paulson also launched a specific gold fund in 2010 called the PFR Gold Fund which according to HedgeTracker had a “long-term strategy focus investing in mining companies and bullion-based derivatives“. This fund does not invest in physical gold, as was highlighted in the BullionStar article “Are the World’s Billionaire Investors Actually Buying Gold?“.

For those unfamiliar with the Denver Gold Forum, this is an annual three-day gathering of gold and silver mining companies, major institutional and hedge fund investors which invest in the sector, and Wall Street analysts covering the sector. In fact, the Forum’s organizers claim that the event represents nearly 90% of the world’s publicly traded gold and silver companies.

Denver Gold Group’s Gold Forum

 

According to an article by Reuters in early June, the nascent Shareholders Gold Council (SGC) has already garnered significant interest from major shareholders in the gold mining sector, and will, at the outset, represent more than 12 institutional and hedge fund investors, including investment institutions such as Delbrook Capital, Tocqueville Asset Management, Livermore Partners, and Kopernik Global Investors, and hedge funds Apogee Global Advisors and Equinox Partners, in addition to New York based Paulson & Co.

Reuters has also reported that major league institutional players such as Vanguard, State Street, Blackrock and Van Eck have also expressed interest in the SGC alliance.

High Cost Base, Destruction of Value

While hedge funds regularly attempt to turn around individual companies, the mobilization of a broad-based shareholder grouping focused on revitalizing an entire sector is still quite unusual, even for Wall Street. It is therefore instructive to examine what motivated Paulson & Co to roll out this idea and pitch the alliance to an entire institutional investment community. Although media coverage has been quite sketchy and exact details of the coalition remain unclear, the Denver presentation given by Paulson & Co’s natural resource specialist, Marcelo Kim provides some clarity, and is therefore worth reviewing.

According to Kim’s presentation ‘Gold Equities: Myths, Dreams and Reality‘, given to the Denver Gold Forum on 26 September 2017, the bottom line is that major gold mining stocks have been severely under-performing both the gold price and the broader equity indices for some time now.

Paulson & Co presentation to Denver Gold Forum, September 2017

This stock underperformance, thinks Paulson & Co, is due to poor investment decisions by said gold mining companies, destruction of enterprise value / low return on capital, and massive writedowns on ill-judged acquisitions, all in an environment of gigantic pay and compensation packages to gold mining company CEOs, clubby and cronie appointments to the companies boards of directors, and low stock ownership (but high options ownership) by these same company executives and board members. According to Paulson’s Kim, “CEOs and Boards get rich while shareholders lose money“.

To illustate, Kim in his presentation highlighted that from January 2010 to September 2017, a timeframe in which the US dollar gold price fell by 20%, the VanEck Vectors Gold Miners ETF (GDX) [which tracks the NYSE Arca Gold Miners Index] returned a negative 45%. Shareholder returns in the junior mining sector were even worse, with the VanEck Vectors Junior Gold Miners ETF (GDXJ)[which tracks the MVIS Global Junior Gold Miners Index] down by 58% over that time-frame.

Even more worryingly, total shareholder returns from 13 large publicly listed gold companies over the January 2010 to September 2017 period was an average negative 65%. However between 2010 and 2016, CEO pay in these same 13 leading gold mining companies was a combined US$ 550 million.

These 13 companies were Eldorado, Newcrest, Newmont, Gold Fields, Barrick, GoldCorp, Yamana, Kinross, AlgloGold, Agnico, Polymetal, Randgold, and Iamgold. All of these companies are members of the World Gold Council except for South African miners Gold Fields and Randgold and the Russian miner Polymetal. Notably, Randgold and Polymetal bucked the trend with relatively healthy shareholder return since 2010 of 35% and 20%, respectively, as well as the highest return on capital (RoC).

Additionally, over the 2010 – 2017 period, the gold mining industry had, according to Paulson and Co “written off $85 billion due to overpaying for acquisitions and massive cost overruns on mine builds“. Gold mining shareholders, said Kim, have no one to blame but themselves, as they had little engagement with company boards, chose not to engage in shareholder activism, but all the while continued to rubber stamp CEO pay, board appointments and mergers and acquisitions. Gold mining shareholders were in short, “like sheep being led to slaughter”.

Whose fault is it? Slide from Paulson & Co presentation

Paulson’s Call to Action

The solution, according to Paulson & Co, is shareholder representation on company boards, investor rights agreements with company boards, company accountability to shareholders, the sacking of poor performing CEOs and board members, and the alignment of CEO compensation with share price performance. As all of these tactics are typical activist hedge fund tactics, it’s not really surprising that Paulson, as an activist hedge fund firm, would make these suggestions.

However, it is in the modus operandus and implementation of the scheme that there is arguably a more radical departure, since this is where the Shareholders Gold Council (SGC) comes in, with Paulson calling for a Council comprising a broad base of major (institutional) gold mining equity holders to come together and make recommendations on board appointments, CEO pay, company takeovers, as well as to make recommendations on annual general meeting (AGM) and extraordinary general meeting (EGM) voting decisions.

But still, is this really a new departure? In one way it is not, because there are perfectly good proxy advisory firms, such as Institutional Shareholder Services(ISS) and Glass, Lewis and Co which between them provide the same type of corporate governance and proxy voting research that Paulson’s Shareholders Gold Council is envisioning, and that are specialists in doing so for every major listed company in the world including every major exchange listed gold mining company.

Call to Action – Shareholders Gold Council (SGC). Slide from Paulson & Co presentation

Paulson and Co’s presentation even mentioned ISS, saying that the new Council would be ‘similar to ISS‘.  According to Reuters’ June article, the Paulson led Council “will begin by releasing research reports on the gold mining sector… betting that shining spotlight on the space will result in greater accountability“. But is this just more of the same?

From a coverage standpoint, there are already countless sell-side (Wall Street) research reports covering all of the world’s leading gold mining companies that are published by a host of investment banks, in addition to umpteen buy-side research reports on the gold mining sector published by countless investment institutions and hedge funds, as well as the aforementioned governance and proxy voting research reports published by ISS and Glass Lewis.

If this new Shareholders Gold Council succeeds in gaining board level representation and in influencing investment and acquisition policy, and CEO compensation and board appointments, then this may in some way make a difference to future shareholder returns in the sector. But at this stage its impossible to say what type of influence, if any, such a Shareholders Gold Council would generate.

The Elephant in the Room

There is one topic, however, that an investor led Shareholders Gold Council could research, analyse and investigate, but for some mysterious reason has chosen not to. This is an issue that goes to the heart of a gold mining company’s operations and the performance of its share price. We are talking here about the actual gold price, how that gold price is discovered and established in today’s gold markets, whether that gold price is manipulated by bullion bank traders, and whether that gold price is subject to central bank interventions that attempt to control and stabilize it.

Simply put, the price that gold mining companies receive for their gold mining output is the most important driver of gold mining share price performance, and not the company’s cost base. We are assuming here that gold mining companies do not hedge their sales. Just look at how gold mining company stocks perform in an environment of a strongly rising or strongly falling gold price. The stock prices move up or down strongly since they are highly leveraged to corresponding gold price changes.

Take for example a simple model of a gold mining company. Its total revenue will depend on how much gold it extracts, processes and sells, and at what price it sells this gold. That’s the top line. The bottom line will be the profits remaining after subtracting total costs incurred by the mining company, which to some extent are fixed. These costs include operating costs (mining costs, processing costs, and corporate, general and administrative costs) and capital expenditure etc. Beyond this, impairments and writedowns on investments will also create an extra hit, as well as merger and acquisition costs.

As the gold price is most often quoted and understood in a price per ounce, the gold mining sector and the investment analysts which cover this sector like to calculate corresponding cost per ounce metrics, including operating costs per ounce of gold produced, total cash costs per ounce, and more recently an All-In Sustaining Cost (AISC) per ounce.

Total cash cost is a historic metric that was devised by the now defunct Gold Institute. It can be viewed as a standard metric for production cost in the gold mining sector. Cash costs would include all costs associated with producing the gold, such as direct production costs, smelting, refining, transport, and administration costs of a mine.

All-In Sustaining Cost (AISC) is a metric introduced by the World Gold Council in June 2013 which aims to try to reflect costs beyond cash costs. AISC includes cash costs but then adds other costs such as general administrative expenses (head office costs) and costs associated with maintaining and replenishing a mining company’s operations, i.e. for sustaining production. It thus includes capital expenditure and exploration costs.

So what Paulson & Co’s Shareholders Gold Council is planning, in addition to publishing research reports, is to try to have an impact on cost reduction, such as reducing CEO and board compensation, as well as to prevent gold miners making costly mistakes on acquiring overvalued mines which they will then have to take writedowns on in the future. This may all be very logical and make a difference in some way, but what the Shareholders Gold Council is not planning to do is to analyse and research anything about the gold price, which is, as was just stated above, the most important determinant of shareholder return and price performance in the gold sector.

Resources & Firepower, but Don’t mention the Gold Price

The Shareholders Gold Council, which on paper will have immense research resources and firepower and influence, will not it seems devote any time or resources to questioning anything to do with the gold price and will just take it a a given. This to me is a completely lost opportunity given that there is ample material for analysis in this area, some of which would surprise institutional and hedge fund investors in the gold space if they bothered to look. Much of this material has been documented on this website and elsewhere, such as by GATA.

The entire structure of the world’s largest and most influential contemporary gold markets has little to do with physical gold. The gold price is predominantly established and discovered in two markets, the London Gold Market and the COMEX gold futures market which between them trade very little physical gold but do trade vast quantities of synthetic gold and gold derivatives. See ‘What sets the Gold Price – Is it the Paper Market or Physical Market?‘.

The vast majority of ‘gold’ trading in the London Gold Market is of unallocated gold which is merely a claim against a bullion bank, and is a form of synthetic or paper gold in as much of a way as the gold futures derivatives that trade on COMEX are. See ‘Bullion Banking Mechanics‘ and an accompanying infographic for details. All gold demand that flows into unallocated paper gold by definition does not flow into physical gold demand, a gold miner’s bread and butter. So unallocated gold syphons off real physical gold demand into a paper substitute and suppresses real demand for physical gold.

There is no trade reporting in the London Gold Market, and the London Bullion Market Association (LBMA) whose remit it is to release it has continually stalled on publishing any trade reporting. This reinforces the opacity of the one of the main gold markets which is responsible for gold price discovery. Nor is there any transparency about where major gold-backed ETFs such as GLD, that store their gold in the London gold vaults, actually source this gold from, some of which is borrowed from central banks.

The SPDR Gold Trust (GLD) – On the NYSE

Nor it there any reporting of any activity in the London gold lending market or of outstanding central bank gold loans or gold deposits. Central bank gold loans are therefore another suppressing influence on the gold price.

This is also ample evidence that the Bank for International Settlements has continually taken a keen interest in the ‘free market’ price of gold and has at times discussed at the highest levels (i.e. the governors of major central bank) how to control the gold price. See ‘New Gold Pool at the BIS Basle, Switzerland’ Part 1 and Part 2.

The COMEX gold futures market is in effect a casino which has a huge influence on gold price discovery but where little physical gold ever changes hands. Some major bullion banks have also been fined recently for manipulating the gold price. These are the same bullion banks which ran the London Gold Fixings and which now run the LBMA Gold Price auctions, auctions whose prices the gold mining companies take to sell their gold output at.

Generally speaking, gold mining executives don’t want to touch any subject related to the  gold price, nor does its representative body the World Gold Council. Now it seems, the institutionally backed Shareholders Gold Council likewise does not want to broach the ‘gold price’ subject.

Which is a shame, for by not examining the issue, and by not using some of their research resources to analyse and investigate and to ‘write reports‘ on the ample evidence of structural inefficiencies and interventionalist forces that hold back the gold price, Paulson’s Shareholders Gold Council, in the same way as the gold mining shareholders which they criticize, will remain “like sheep being led to slaughter”.