Sunday, January 27, 2008

Deconstructing the S&P/TSX Global Gold Index

27 January 2008

I have found a new way to look at the S&P/TSX Global Gold Index (which I shall refer to by its StockCharts symbol, SPTGD, for convenience).

The SPTGD index consists of
25 precious metal mining companies traded on the Toronto Stock Exchange (TSX). Those companies and their current share prices are listed here.

rules for including a gold mining stock on the SPTGD index are as follows:

- Listed for at least 12 months on TSX, NYSE, NASDAQ
- Included under the Global Industry Classification System (GICs) Code 15104030 – Materials - Metals Mining – Gold
- Minimum float market cap of US$300 million based on three day VWAP
- Average daily dollar value traded of at least US$1 million for the two months preceding a security’s consideration as a candidate for inclusion
- Liquidity ratio (dollar value traded/average float market cap over past 12 months) of at least 0.30
- No more than 25 non-trading days over the past 12 months

The S&P/TSX Global Gold Index is calculated based on a modified market capitalization approach, as follows:

"On any given day, the index value is the quotient of the total float-adjusted market capitalization of the index’s constituents and its divisor. Continuity in index values is maintained by adjusting the divisor for all changes in the constituents’ share capital after the base date. This includes additions and deletions to the index, rights issues, share buyback and issuances, and spin-offs. The divisor’s time series is, in effect a chronological summary of all changes affecting the base capital of the index. The divisor is adjusted such that the index value at an instant just prior to a change in base capital equals the index value at an instant immediately following that change."

At face value, things look pretty good for the SPTGD index, as it is the best performing index of the current (albeit so far brief) millennium on the TSX exchange since 2001:

In fact, the TSX is the best global exchange for financing mining exploration and development, as the following chart reveals:

Here is the problem.

The ascending Canadian dollar and the vagaries of the mining business have caused the SPTGD index to underperform its rival, the AMEX Gold Bugs Index of unhedged gold mining companies (the “HUI”) by a dramatic margin. I have been writing about this problem for some time now.

This is all the more striking, as the HUI index for the most part consists of many of the same gold mining companies as are listed on the SPTGD index (link).

The differences are (1) the HUI index consists of a smaller number of capitalization weighted companies, and (2) the SPTGD index is priced in ascending Canadian dollars, while the HUI index is priced in collapsing US dollars.

The Canadian dollar has climbed almost exactly 60% against the US dollar, since reaching its early 2002 low of $0.6192 US.

But this is the shocker…. The SPTGD index declined 74% against the HUI index from its relative peak in late 2000 to its relative November 2007 low. By any measure, that is a dramatic collapse in relative value. That is, the multiplier required for the November 2007 low on the SPTGD index to recapture its (original high) December 2000 value is a factor of 3.8 – dwarfing the gains made by the Canadian dollar.

Here is the rub – US investors, holding weakened US dollars, who have invested in the HUI index since the last quarter of the year 2000 have done far, far better than Canadian investors who have held the SPTGD index in Canadian dollars over the same period.

To put it in the most dramatic terms possible, the HUI index, admittedly in weak US dollars, outperformed the SPTGD index by a factor of 425% for the period December 2000 through November 2007. This while the Canadian dollar gained only 60% during roughly the same period. In this chart, we are looking at the same phenomenon as before, just in reverse:

That is, the HUI gained a relative 425% for US investors while their currency fell only 38% against the Canadian dollar. Subtracting the 38% currency loss erodes the HUI gain by 162 percentage points, but leaves US HUI index investors still with an absolute gain of 263% against Canadian SPTGD index investors during more or less the first decade of the present millennium – this subtracting all influence of the ascending Canadian Loonie.

To sum it up, in Canada, with a soaring Canadian dollar and the world’s best climate for funding mining ventures, there has been no relative advantage of investing in the SPTGD index over the course of the present decade to date. Far better to be an American, holding a collapsing currency, but investing in the HUI index.

There is no other way to look at it.

Now that the Canadian dollar has reached parity, and probably topped out against the US dollar for some time to come (as the “carry trade” currencies, such as the Swiss Franc and the Japanese Yen now find favour in international currency markets against the backdrop of a looming global recession), will Canadian gold mining stocks find any greater traction compared to their American-listed counterparts than before?

My short answer is… “I'm not sure.”

The trend continues to favour the
AMEX Gold Bugs Index (the HUI) against the S&P/TSX Global Gold Index (the SPTGD) until it doesn't.

1 comment:

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