Thursday, April 24, 2008

Why the XAU is not a pure gold stock index any longer

Below you will find today's TA on the HUI gold bugs index. The HUI represents unhedged gold producers, while the XAU Philedalphia Gold and Silver Index represents a broader range of precious and now base metal producers. After reading the comments made by Frank Barbera I have stopped looking to the XAU as a measure of gold stock performance as its largest holding is more of a copper producer than gold.

The HUI chart below highlights the peak reached in the May 2006 run up which we are approaching at this point, along with various trend lines that may become more significant going forward. These multi-day plunges are painful for gold stock investors and there may be more to come in the upcoming weeks but this drop is still no where near exceptional.

Frank Barbera: $XAU: $HUI

The good folks at the Philadelphia Stock Exchange decided awhile back to include Freeport McMoran Copper and Gold (FCX) within the XAU. Their argument was that FCX is a major gold producer, --period. However, FCX also produces a lot more Copper then Gold, with up 85% of the companies revenues coming from sales of Copper. Thus, FCX is more a Base Metal stock, then it is a pure play Precious Metal stock. What’s more, FCX trades precisely along the same lines as other big name Base Metal stocks like BHP Billiton (BHP), RTZ Corp (RTP), Teck Cominco and Rio Dulce (RIO). It trades in a very different pattern then Gold Stocks and as a result, we would argue that it should not be included in the XAU or any other Gold Index.

Well, that argument has gotten us no where despite many calls to the PHLX. What is important, is to watch FCX as it presently accounts for 22.34% of the total index, by far and away the heaviest weighted component of the XAU with Barrick Gold currently at 18.29%, Newmont Mining at 9.95% and Goldcorp at 14.05%. Essentially, FCX is worth GG and NEM combined! Since April 1st, ABX is down from $41.92 to today’s close of $40.80, NEM is down from $44.80 to today’s close of $43.85, and GG is up slightlyfrom $37.46 to today’s close of $38.44.However, since April 1st, FCX is up 25.64 dollars per share, from $97.63 to a high today of $123.27, for a percentage gain of 26.26%. Since every one dollar in FCX stock kicks in 2.85 index points into the XAU, the 25.64 point gain in FCX has added 73.25 index points into the XAU since April 1st.

That is huge! And that is why the XAU is holding up much better then other Gold Indices, for the simple reason that since the beginning of April, FCX has skewed the XAU sharply to the upside causing the index not to reflect the real sideways action which has taken place in precious metals mining stocks. We can see all of this graphically on the charts below, with FCX moving to new all time highs and in the process skewing the XAU to the upside, with a super bullish bias.

If instead of the XAU, we use the HUI – Amex Gold Bugs Index, or the GDX ETF, which tracks the MarketVectors Gold Mining Index, we see that both of these other indices are now fully back to the March and April lows .

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