The number, market cap and currencies of the constituents of the HUI, XAU, GDX, XGD and CDNX indices differ considerably from each other and, as such, each index presents a different picture of what is really happening in the precious metals marketplace. This article analyzes the make-up of each index to reveal the biases of each to arrive at the answer to the question in the title.
The HUI Index
The AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index (HUI) is a modified equal dollar weighted index of 16 large-cap (80%) and medium-cap (19.5%) gold mining companies that do not hedge their gold beyond 1.5 years. The 3 largest companies make up 41% of the index by weight with the remaining 13 companies, at 4% – 5% each, making up the balance.
The XAU Index
The Philadelphia Gold and Silver Sector Index (XAU) contain 16 large (83%) and medium (15%) capitalization weighted companies engaged in the mining of gold, silver and copper. The same 3 largest companies as in the HUI account for 51% of the index by weight. As such, the XAU has a large-cap bias.
The SPTGD (XGD) Index
The S&P/TSX Global Gold Index (SPTGD) consists of 64 modified market capitalization-weighted companies (78% large-cap; 19% medium-cap) involved in precious metals (primarily gold) mining. The 3 largest cap companies dominate the index with 42% by weight. A proxy for the index is the XGD which trades in Canadian dollars on the Toronto Stock Exchange. As such, the XGD has a currency bias which is explained below.
The GDM (GDX) Index
The NYSE Arca Gold Miners Index (GDM), as represented by the GDX etf (see here for details), is a modified market capitalization weighted index of 30 companies (72% large cap; 22% medium cap) involved primarily in the mining of gold and silver. The 3 largest cap companies again dominate the index (at 30% by index weight) but to a much lesser extent than in the HUI (41%), the XAU (51%) or the XGD (42%). As such, the GDM/GDX has a medium-cap bias.
The CDNX Index
The S&P/TSX Venture Composition Index (CDNX) consists of 558 micro cap companies of which 44% are involved in the early stages of the exploring, developing and/or mining and 18% in oil and gas exploration. This is the only index that gives insight into the price trends of micro-cap companies almost exclusively (99.4%). The CDNX is valued in Canadian dollars and, as such, has a currency bias like the XGD.
How Best to Apply the Various Gold:Gold Stock Ratios
The Gold/HUI, Gold/XAU and Gold/GDX Ratios
The Gold/HUI, Gold/XAU and Gold/GDX ratios divide the daily close of the price of gold by the daily close of the value of the particular index and, when charted over time, provide an excellent running representation of relative strength and weakness between the two variables. That being said there are significant differences between these indices, as follows:
a) the Gold/XAU ratio emphasizes what is happening primarily in relation to the large-cap producers;
b) the Gold/HUI ratio emphasizes what is happening in relation to the large/medium-cap producers;
c) the Gold/GDX ratio emphasizes what is happening primarily in relation to the medium-cap producers
The Gold/XGD and Gold/CDNX Ratios
The Gold/XGD and Gold/CDNX ratios, on the other hand, compare gold denominated in U.S. dollars with stocks denominated in Canadian dollars. This has the potential of skewing the results depending on the strength of the two currencies relative to each other and, as such, should not be used when evaluating the trends of their constituent stocks with that of gold bullion.
(To develop your own G/GS ratio chart go to www.stockcharts.com and type in $GOLD:$HUI, $GOLD:$XAU, etc. for the time frame you wish to examine.)
The CDNX/XGD Ratio
To identify developing macro trends between large/medium cap producers and micro/nano precious metal explorers (the juniors) the ratio to follow closely is that of the CDNX/XGD which, in addition to highlighting the two different ends of the spectrum, are both valued in Canadian dollars.
As mentioned above, the XGD index follows the performance of 64 large, medium and small-cap companies and the CDNX that of 558 micro-cap companies. Comparing the divergence of each index to the other is an ideal way to determine if a developing trend is equally affecting all mining shares in general, just the large/medium/small-cap sector or just the micro-cap venture capital sector.
The CDNX to XGD comparison works better than that of the CDNX to any one of the other mining sector indices in that both the CDNX and the XGD are traded on the Toronto Stock Exchange in Canadian dollars whereas the HUI, XAU and GDX indexes are denominated in U.S. dollars and, as such, are susceptible to the influence of exchange rate variances when comparing any one of them with the CDNX.
Gold sector analysts and commentators always assume that the large-cap dominated indices, either alone or in relation to gold, indicate the true current trend of the entire precious metals mining sector but that is simply not the case. In doing so they ignore the health and, as such, the price performance of the micro-cap gold and silver exploring/developing/mining companies which represents in excess of 80% of the total number of companies in the precious metals sector. A comparison of the CDNX with the XGD reveals a much more accurate picture of what is truly happening in the gold mining sector.
Conclusion
So there you have it. You now know the strengths and weaknesses of the more popular gold stock indexes, which ones to use when determining their relationship with gold bullion based on their market cap and how to compare the performance of the large/medium cap sector with the micro/nano-cap sector.
Never again put any credence in any analysis you read that has not made the distinctions discussed above. All gold stock indexes are not the same. Each has its own bias. Each tells its own – and different - story.
