Is HUI Gold BUGS the Best Bet for Gold?

By J. Keith Johnson - April 18, 2012 | Tickers: GDXJ, GDX, GLD, PHYS | 0 Comments

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At this point it seems that only hard core gold bugs, sharp long-term holders, and a few savvy analysts have stuck with the Midas metal. While that’s easy to understand in light of gold's recent selloffs and largely sideways movement, as we’ve recently discussed, this retraction could very well end up being the last great buying opportunity for quite a while.

For the long haul, there’s really no substitute for owning physical metals. However, for those who’ve already allocated metals to their portfolios, it looks like we might have a very nice setup for a play on gold that’ll outperform the physical in the short to mid-term.

Readers have likely heard of the Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (AMEX: $HUI).

The NYSE Arca Gold BUGS Index 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. AMEX

The current weights that comprise the index are as follows.

On March 15^th, the day that the HUI was pegged at $200, gold closed at just under $396, placing the AU/HUI ratio at just shy of 2 to 1. Considering gold’s reluctance to depart from 1650 in recent weeks, if the original ratio had held, the HUI would currently be meandering around the $825 mark rather than its current struggles in the 450s. As you can see in the chart, this departure from gold has historically ebbed away from gold for a bit, then rose toward the 2/1 ratio again. It’s obviously not a perfect model, but with recent movements there is some historical precedent that suggests we might see a powerful upward move in the near future.

When gold departed from its 2008 highs, the HUI descended as well, though with much more volatility than gold’s move would seem to warrant. By the time the dust had settled, the ratio had fallen from over 2-1 to almost 5-1. For savvy investors this turned into an excellent opportunity as both gold and the HUI climbed over the next year, coming short of the 2-1 ratio, but surpassing the 3-1 ratio.

Fast forwarding to gold’s recent challenges, we see another departure from gold’s prices. While this has many analysts baffled, they’re also recognizing that this is likely to offer another excellent buying opportunity. Consider that the current ratio is almost 4-1 again. When gold begins the next ascent, it will again turn buyers’ attention to the miners; at which time the HUI will most likely close the ratio again, offering stronger returns than the metal alone. If history rhymes and the ratio gains 3-1 again, if gold gains a very respectable 21% and reaches $2100 later this year (an estimate popular with many analysts) we could see the HUI surpass $700, a gain of 35%.

The HUI can’t be traded, but Gold Miners (NYSEMKT: GDX) and Junior Gold Miners (NYSEMKT: GDXJ) can, and the Philadelphia Gold and Silver Index offers option contracts. Gold can be traded via SPDR Gold Shares (NYSEMKT: GLD) and Sprott's gold ETN (NYSEMKT: PHYS).

Consider your options as you prepare for the next move. There is no substitute for owning gold. But there may be some great trades offered by those who dig it up for us.

For your prosperity,
J. Keith Johnson
The Gold Informant

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