"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Tuesday, January 17, 2012

Gold stocks continue being plagued by the hedge fund ratio trade

The HUI continues to lose value against the price of gold bullion as evidenced by a continued deterioration in the ratio of the price of the HUI to the price of an ounce of gold.

We are reminded continually of two things that have led to this abysmal performance of the gold shares which are rapidly losing speculative interest in favor of the ETF.

The first is the risk of investing in companies that are subject to surprises which happened to Hecla and recently to Kinross. Hedge funds and other large investment groups or players seeing this say to themselves, "Why risk this sort of thing when we can get LEVERAGED EXPOSURE" to the gold price by buying the gold ETF on margin".

There is no such risk inherent in the ETF. No one worries about nationalization of the ETF or environmental lawsuits or some bureaucratic agency shutting it down to clean up debris in a mine.

Secondly -this then leads us to the ratio spread trade. Buy the actual metal either through the ETF or the physical stuff (or even the Comex) and take a corresponding short position in some of the mining companies to further minimize the risk of investing in gold.

This shows up in the rotten performance of the gold shares in general as they continue to decline against the price of bullion . Note that the line goes nearly straight down since the beginning of 2011 with a brief exception of a lousy two months last year.

If one wanted to devise a mechanism to deliberately depress the price of the mining shares they could not have come up with a better mechanism to do so than the gold ETF. The lesson in this is that investors must be extremely selective in choosing gold mining companies to invest in and not just blindly throw money into the sector and thereby hope to be successful. As long as the Gold ETF is in existence, the hedge funds are going to use it as the long leg of these spread trades and actively seek out the weaker gold mining companies to short. At this point I am not sure what it is going to take to reverse this trade as traders will stick with a strategy as long as it works and not a day longer. Long suffering gold mining share owners should continue to press management to take the steps necessary to make it more difficult to short their shares successfully. Failing that they can always pray for a takeover or acquisition!


  1. Thanks Dan for your observation of what is going on with the mining shares. Maybe miners can get some lessons from your insights and do something about their growing bad situation. With share prices depressed and producers making good cash flow/profits, the miners can indeed fight back. In my opinion, surprise consolidations/takeovers and strong dividends would indeed help stem this ratio trade.

  2. Dan - short sellers are not the problem, crappy management and results are the problem. Just look at the example you brought up: Kinross. It wasn't down 15% because of short sellers, it was down 15% because they're not executing.

    Multiple hedge funds have gone vocally public with their opinion that the miners are cheap compared to gold - swapping out of gold and into GDX, or putting on a long GDX short GLD pairs trade. Einhorn and Sprott are two recent examples.

  3. Start a juicy 3% plus dividend to mitigate this problem. I'm mostly out of the miners until they show significantly more interest in developing shareholder value.

  4. Recent bad news out of HL and KGC are the only reason the HUI hasn't been uptrending over the last week or so.

  5. Another sour note on the miners. It seems to me there are far too many naysayers on the prospects of the miners something that is far different than what prevailed for the better part of 2011. This may not be bullish for tomorrow or next week or even next month but i can assure you it VERY BULLISH for anyone thinking beyond "tomorrow".

  6. Agnico Eagle also got hit really hard a few months ago because of their issue with the Goldex mine.

  7. Some miners have less than perfect management, others just get whacked off their feet and have to fight back. Just look at what happened to Silver Corp Metals, huge short positions were opened and then some guys calling themselves AlfredLittle started publishing unfounded rumors. Regulators investigated the rumors and proved them wrong. Even Muddywaters got in on the action and also said they would be shorting SVM.

    As for the hedge, Long Gold / Short Gold_Miners, it's so popular; for crying out load, it's even used as an example in books on Quantitative Trading!

  8. Well, I must admit I just so happened to have recently purchased some HL, AEM, SVM and KGC. Just waiting for the upside gaps to fill and then I'll wait and see who gets picked on next. :)

  9. Hey Dan Ha ha ha ha ha

    Newt Gingrich Calls for Commission on Gold


  10. What's the basis for this alleged hedge fund pair trade? The short interest in the worst of the worst big cap miners, KGC, is minimal. NEM is around 2%.

    The only vehicle (which I could find in a quick search) that has significant short interest is GDX at around 6%. That's about the same as GM.

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  12. Dan, thanks for all the insight. Since you mentioned Kinross, I thought I'd share some thoughts on the miners. It seems to me that Kinross would be a juicy strategic target for the Chinese/CIC. Not that retail investors would necessarily gain much. I think the Hedge funds are selling the West's birthright for a mess of pottage:
    1. China is increasing its gold reserves, some analysts say by buying directly from miners.
    2. KGC is a major producer, a "big 10" produce, and so could make a dent in chinese demand.
    3. KGC is very attractive, hobbled, now.
    4. China OWNS Ecuador (fruta del norte mine)--Ecuador owes China ~$8 billion USD or ~20% of GDP (Google Felix Salmon, Ecuador, China)--so China would have huge leverage with said country / windfall tax.
    5. China has long-standing relations, rock solid, with Mauritania (Tasiast) (so again, could lever against any 'supertaxes.'
    6. CIC already has a small investment in KGC (about 210k shares in 2009), as well as a large investment in Blackrock, which itself owns about 10% of KGC through its various global entities...


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