The Structure of S&P/TSX Global Gold Index (SPTGD) Uplegs

February 27, 2008

Adam Hamilton recently published a formative piece on the Amex Gold Bugs ("HUI") Index, entitled "HUI Upleg Structure." Mr Hamilton develops several theses, some built on his earlier work, which has examined HUI leverage to gold. Foremost among his ideas is that the market price of gold mining stocks, as represented by the HUI index, continues to be leveraged positively to gold, the underlying commodity which the miners produce.

Mr. Hamilton also notes that HUI uplegs generally see two primary downtrend corrections while maturing, the first of these usually starting around the 63rd trading day (about the end of their third month). In his view, the function of these downtrends is to function as "a safety valve to prevent popular greed from growing too extreme before an upleg nears maturity."

Most importantly, Mr. Hamilton concludes that HUI uplegs see 47 to 60% of their gains in their final two months. Thus, only investors who hold on to the end are fully rewarded.

Of particular interest, Mr. Hamilton notes that the current gold surge is clearly the strongest of the 2000-present gold bull market, and also that the current HUI upleg has in fact demonstrated the strongest first stage of all of the (now four) "massive" HUI uplegs to date.

I could tell you more, but of course it makes more sense for you to read the article for yourself.

Here is the rub for Canadian investors.

No one has attempted a comparable analysis of the (so far comparatively underperforming) S&P/TSX Global Gold (SPTGD) Index. Unfortunately, I lack the sophisticated charting tools that Mr. Hamilton has available, so it is not possible for me to undertake a similar analysis here.

But let me perhaps offer an introduction to the topic of upleg structure (and leverage) for Canadian gold investors.

Let's begin with charts of the four uplegs of the SPTGD, which I discussed in greater detail on January 27, 2008.

Here is chart number one for your delectation:

The first SPTGD upleg, which occurred prior to the rapid escalation in value of the Canadian currency, has so far demonstrated the greatest gains for Canadian gold stock investors. This 19-month-long upleg started out at a humble value of 83.97 in October 2000, and proceeded to advance 178% to 233.08 in May 2002.

By the way, the HUI has outperformed the SPTGD from the very beginning to the present. It is one long outperformance on the part of the HUI, and currency differentials alone do not explain it. (The HUI has most dramatically outperformed the SPTGD index since the Canadian dollar initiated its long climb, which happened to begin in about January 2003.)

Strikingly, SPTGD upleg one shows no sign of the dramatic correction periods which Hamilton observed in all of the HUI uplegs, though a series of minor, or "soft" corrections, enduring no more than two months, can be seen.

Suffice it to say that Canadian investors who were shrewd enough to ignore the internet craze and purchase gold mining shares in 2000 have had no regrets since that time. They have been amply rewarded for their initiative, insight, independence and timely action.

Let's now look at SPTGD upleg number two:

Please note that in this preview article, I am ignoring the intervening downlegs, which, as Hamilton points out, tend to bleed off excess positive sentiment even in the strongest of bull markets.

From a starting value of 137.02 in July 2002 (representing a 41% decline from the peak value of the previous upleg), SPTGD upleg number two in fact climbed only slightly higher than upleg one, to a value of 244.47. This was also a brutal and unruly upleg, with three sharp, severe and dramatic corrections, the third of which in March cruelly took Canadian gold stock investors back to where they had started 8 months earlier, in July 2002. The discerning Canadian gold investor could have sat out this ugly but ultimately rewarding upleg!

However, for those who were late to the party, upleg two certainly provided another chance to get into the game, with a 78% gain (I bought my first gold stocks in June 2003, which, as is often the case with beginner's luck, happened to be an exceptionally fortunate time to buy).

SPTGD upleg number three returned to the gentle, steady climbing pattern of upleg number one, as can be seen below:

Upleg number three advanced through a series of gentle, upwardly rolling minor corrections which exceeded one month in duration on only a single occasion, for a 122% maximum gain from May 2005 to May 2006. This was a slow, steady, and rewarding upleg which I remember fondly as a fully invested Canadian gold stock investor at the time.

I recall seeing a greater than doubling in our personal portfolio value from its previous correction low during the advance of this particular upleg, and, save for upleg one, upleg three remains the best one-year period for Canadian gold stock investors since the 2000-2002 upleg.

Note that upleg three started from a value of 166.76, and rose to a very respectable 369.72.

The correction preceding this upleg was a relatively modest but very extended and grinding 32% sideways correction which persisted for a brutal 17-1/2 month period, discouraging many Canadian gold stock investors, who watched the US dollar price of gold climb steadily while Canadian gold shares could muster only a 32% decline!

Without going into a level of detail which is beyond my present purposes, let it suffice to be said that the downleg from May 2006 through August 2007 was another horrendous one.

From a high of 369.52 in May 2006, the SPTGD plummeted in three vicious corrections to a numbing low of 240.42 in August 2007, revisiting the SPTGD peak value of a full 5 years and 3 months earlier, in May 2002.

Let me say that another way. Canadian gold stock investors could have sold everything in May 2002, and done nothing for over 5 years, until buying back at the same prices in August 2007! American HUI investors still saw their investments double (from the 2002 HUI high to the 2007 HUI low) during that same period. It was not a good 5 years to be a Canadian gold stock investor!

Nothing corresponding to the inglorious May 2006 through August 2007 SPTGD correction can be seen in the HUI, which handily outperformed the SPTGD during this period, even accounting for the plunging US dollar!

Now, let's look at the current upleg in the SPTGD index, which, as mentioned, started at a modest 240.42 value in August 2007.

Of course, we are not yet done with the current upleg. As of January 14, 2008 (its peak so far), upleg four has advanced as much as 59% from its August 2007 low. This can be compared to a 72% gain in the HUI during the same period.

Certainly the current upleg has seen one dramatic advance followed by a sharp correction in the December-January period. However, the January low has so far held, and the index is presently advancing along with gold, which in Canadian dollar terms has surged from $679 to $969 during the same time frame following August 2007, for a 43% gain, upleg-to-date.

What does the future hold in store for the SPTGD index?

Well, the Canadian dollar is now at parity with the US dollar, and I think we will more or less stay there for some time to come, as currency markets need to digest the Canadian dollar's 65% gain from January 2002 through today's date. This means we shall most likely see the true test of the SPTGD against the HUI on equal terms over the next few months. So far, the HUI has been the clear winner, and 2008 will tell if any change in that trend may possibly emerge.

Please allow me to close by agreeing with Mr. Hamilton on several points.

Our present analysis of SPTGD upleg structure shows that Canadian gold stocks, similarly to those constituting the HUI, clearly see their best gains in the final two months of their uplegs. Even sizable intermediate losses can be recovered simply by holding through to the end of the upleg. That is, one must allow the upleg to finish its course, and impatience is of no benefit to any investor. Another pattern that is very clear in the structure of SPTGD uplegs is that there are often significant corrections just prior to the final upleg surge. It would be particularly onerous to sell on these final plunges in the SPTGD, as the darkest hour is very typically just immediately before the dawn for SPTGD investors.

The duration of SPTGD uplegs has so far been 19, 15 and 12 months. Thus it seems probable that our present 6-month upleg is far from maturity, as there could be a further 6 to 12 months to go, and the duration would simply be typical.

Given that gold's present upward momentum is its strongest in the present bull market to date, it is reasonable to expect that if the value of gold shares continues to leverage the price of gold, then gold shares could be considerably higher than they are now in 6 to 12 months' time.

And of course, a note of caution must also be sounded. With gold's stronger than usual run to date, greater and sharper than typical corrections are also very likely. And any lasting downdraft in the price of gold will be sure to wreak considerable damage in gold stock valuations. So some quite powerful corrections are probably quite likely between here and the next peak in Canadian gold stock prices.

Perhaps the most satisfying aspect of our present situation is that we seem still to be in the relatively early stages - at least nowhere beyond the broad centre - of the current SPTGD upleg.

SPTGD upleg four may not unfold in the way that we would most desire (events in investing seem designed regularly to unnerve even the most savvy investors), but there are nonetheless likely to be further very satisfying gains in the SPTGD index in the months ahead!