Trading the Relative HUI

Adam Hamilton     September 12, 2003     3173 Words


What a magnificent week for gold-stock investors and speculators!  The powerful secular bull markets in both gold and gold stocks continued unabated, defying the legions of Wall Street naysayers and marching relentlessly higher.


The flagship unhedged gold-stock index, the mighty HUI, managed to power its way up to stellar new bull-market-to-date highs mid-week.  The HUI blasted above the psychologically crucial 200 mark, a big important round number that precious-metals bulls have long lusted after.  The glorious fall of HUI 200 is a very important and noteworthy milestone in this awesome young bull market in gold stocks.


And what a bull market it has been!  Even though to this day there remains only a relatively small percentage of investors and speculators who are aware of it and even fewer who are actually risking their own scarce capital in this galloping bull, the HUI performance thus far has been absolutely breathtaking.


As of this past Tuesday, September 9th, the HUI is up a gargantuan 467% in its bull market to date!  467%!  A huge 467% gain in a little under three years is a staggering sector performance by any standard, and I strongly suspect that if these magnificent gains had been achieved in a politically correct market sector instead of precious-metals stocks it would no doubt be front-page financial news trumpeted far and wide every day.


Yet, since there is still a powerful cultural bias against precious metals investing and speculating in the Wall Street establishment these days, the teeming masses unfortunately remain largely ignorant of the greatest major bull market unfolding on the planet today.  This is truly sad for those being kept in the dark by their financial advisors and brokers, but it is wonderful for the prudent contrarians already riding this bull as it grants us more time to accumulate before the thundering herd eventually arrives and forces precious-metals prices into the stratosphere.


In every Great Bull market in history it was always the farsighted contrarians who bought in early, well ahead of the popular crowd, who were blessed to amass the greatest fortunes.  Our currently unfolding gold bull today will certainly prove to be no exception to this ancient rule of wealth accumulation in the financial markets.


A HUI level of 200 is a rare event in modern history.  In order to find the last time the HUI traded above this heavy 200 mark, one has to gaze across a relatively large gulf of time of many years way back to the summer of 1996.  The contrarians long the precious-metals arena ought to rejoice this weekend, as the wonderful blessing of HUI 200 has certainly been a long time coming.


Nevertheless, while absolute index levels are always interesting and even sometimes exciting like the HUI 200 achieved this week, the real game of speculation relentlessly unfolds in relative terms.  While this doesn’t matter anywhere near as much to long-term buy-and-hold investors, gunslinging PM speculators are constantly striving to understand whether a given HUI level is relatively high or relatively low at a particular moment in time.


If the HUI seemed to be relatively low, obviously the speculators would seek to add to their PM related positions, expecting a mean reversion back up to relative normality or even relatively high territory.  Conversely, if the HUI seemed to be relatively high, speculators could sell outright or raise their stops in anticipation of a mean reversion pullback to more relatively reasonable HUI index levels.


This crucial concept of relativity addresses the constantly shifting absolute index baselines of a secular bull market.  Way back in early 2001 a HUI level of 100 seemed staggeringly high, but today this very same HUI level of 100 seems dreadfully low.  The speculators engaging in the thrilling PM arena these days need to develop tools to help them discern when a given absolute HUI index level is relatively high or when that very same index level is really relatively low.


As I have oft-discussed and lamented on in these essays, because the PM world has been out of favor with Wall Street for so long there are relatively few pre-packaged indicators available to PM investors and speculators.  Since we unfortunately don’t yet have a gold equivalent to the VIX or similar elite general-stock indicators, we need to handcraft our own technical tools to help us discern when it is probably the right time to buy, hold, or sell.


One such indicator is the Gold 50/200 MACD which I introduced earlier this year.  The ongoing intricate dance between the 50-day and 200-day moving averages of the Ancient Metal of Kings is fascinating and has already thankfully proven quite profitable to trade upon.  We have been zealously working on cultivating a healthy stable of these guerilla PM speculation indicators at Zeal this year and there are several others that we have been quietly internally watching and backtesting over the past six months or so.


I would like to formally introduce another of these homemade PM speculation indicators this week.  It is very relevant to the primary concern among PM speculators today, whether today’s awesome HUI 200 levels are relatively high and hence overbought or relatively low with potentially more room left to run.  This new tool that we have been playing with at Zeal since spring is an exceedingly simple concoction that I call the Relative HUI.


As always, these guerilla indicators are far easier to communicate and assimilate in graphical form, so a couple graphs are in order to lay out the foundations, logic, and reasoning behind the idea of the Relative HUI.  Our first graph is a simple comparison of the gold price to the HUI, along with the HUI’s 50dma and 200dma.


Please note that the left gold axis is not zeroed in order to better highlight gold’s price movements, while the right HUI axis is zeroed.  The HUI’s magnificent gains to date have vastly leveraged and outpaced those of gold, which is not readily apparent in a graph like this one designed to zoom in on gold’s volatility.  If gold was graphed on a zeroed axis as well, its upslope would be far more moderate than that of the HUI.



Other than the immensely joyous tidings of the glorious fall of HUI 200, there is nothing remarkable about this standard graph.  In order to understand the reasoning behind the Relative HUI indicator concept, please carefully examine the blue line, which represents the absolute headline HUI index level, in relation to the black line, which represents the HUI’s 200-day moving average.


Since early 2001, the HUI has spent the vast majority of its time above its 200dma.  This behavior is quite normal and expected in a secular bull market.  With a whopping 200 days of trading data crunched and compressed into this number, the 200dma is one of the best proxies for a long-term trend in any given market.  Indeed, once a trend is established the 200dma even tends to run close to parallel to the index’s primary trend channel.  This is easy to see above, with the blue HUI line maintaining a very similar average upslope to its black 200dma line.


If you closely examine the HUI and its 200dma together over the past few years, you will note that the HUI generally oscillates between pulling significantly above its 200dma and then migrating back down to its 200dma.  This behavior is also par for the course in a primary bull market, and it has great significance for PM speculators.


In the entire bull market in the HUI to date, speculators would have done quite well if they limited their buying to times when the HUI was flirting with its 200dma.  Each time after these convergences between the HUI and its 200dma, the flagship unhedged gold-stock index was poised for another major upleg.  Buying any major bull market near its 200dma is old and fire-tested speculation wisdom that very often proves to be quite successful.


On the other hand, the HUI uplegs tended to end when the HUI overextended itself too far above its 200dma.  Eventually the irresistible gravity of that heavy 200dma line always wins out and drags the HUI back down for a healthy pullback.  Speculators would have been well served to sell their PM trades outright or ratchet up their trailing stop-losses when the HUI stretched too far above its 200dma.


Now these ideas are simple and easy to implement, but the weak link in actual execution remains our mortal human eye.  You and I can’t merely eyeball this graph, especially when the HUI is far above its 200dma, and somehow just know how overextended it has become.  Yes, we can see when the HUI is at or above its 200dma, but we can’t visually discern exactly how far and how it compares to earlier HUI uplegs.


In addition, on a standard linear graph scale like this one the same vertical distance measured at the top or the bottom of the vertical Y-axis corresponds to a very different percentage.


For example, way back in early 2001 when the HUI traded at 40, 10 absolute HUI index points were huge, a 25% gain!  Today at HUI 200, these very same 10 absolute HUI index points only represent a trivial 5% gain.  The higher that an absolute index scale trends, the greater the visual skew in its performance percentages grows when it is presented on a standard linear graph.  An index point today is not worth the same as an index point yesterday or an index point tomorrow!


In order to capitalize on the tantalizing interaction between the HUI and its 200dma to use for actual speculation decisions in real-time, we can distill this visually difficult-to-measure distance down from absolute index numbers which are skewed to a standardized percentage reading, which never skews and remains constant at all index levels.  The Relative HUI accomplishes this technical feat.


Calculating the Relative HUI couldn’t be easier!  All you have to do is divide the HUI by its 200-day moving average on any given trading day.  Piece of cake!  This past Tuesday the HUI closed at 204.08 and its 200dma hit 143.35.  This 204 HUI close divided by its 143 200dma yields a Relative HUI for that day of 1.43.  This measurement effectively shows the percentage above or below its 200dma at which the HUI happens to be trading at any moment in time.


This Relative HUI 1.43 example means that, on September 9th, the HUI was trading about 43% higher than its rock-solid 200dma support.  A Relative HUI reading of 1.25 would indicate that the HUI was trading 25% higher than its 200dma (or stated another way, at 125% of its 200dma), while a 0.80 reading would indicate that the HUI was only trading at 80% of its 200dma.  The Relative HUI is one number that PM speculators can look to anytime in order to gain a quick read of whether the HUI is relatively highly priced or relatively lowly priced compared to its all-important 200dma.


This Relative HUI concept helps to kill multiple birds with one stone.  First, it provides another potential guerilla indicator for PM speculators to use in order to make decisions of when to add to or lighten their PM trading positions.  Second, it removes the imprecision and great subjectivity of just analyzing a graph visually.  While our eyes can make lines seem deceiving at times, a specific empirical Relative HUI is always perfectly accurate and immune from bias.


Finally, the Relative HUI indicator neutralizes the inherent skew that builds up in standard linear index graphs over time.  A Relative HUI reading of 1.20 means that the HUI is trading 20% above its 200dma at any stage in its secular bull market, regardless of if its absolute index level happens to be in the 40s or 200s or beyond.  The empirical Relative HUI hard-quantifies the crucial difference between the HUI and its 200dma.


If this methodology seems hauntingly familiar to you, perhaps you have been following our work on the VIX implied volatility index for the S&P 100 earlier this year.  This past spring I penned some essays on the idea of the mechanically identical Relative VIX, which we developed for the same reason.  We needed to understand if the absolute VIX was relatively high or low at any given time, and looking at it in reference to its 200dma solved the problem.  Much more background on this general “relativizing” approach is developed in the “Trading the Relative VIX” essay and its sequel.


When graphed, the Relative HUI offers some excellent insights into the longstanding relationship between the HUI itself and its 200dma that are not apparent in a standard chart like the one shown above.  All the visual subjectivity and graph skew in observing the absolute HUI index alone are removed and a far sharper technical trading tool emerges from the simple Relative HUI computation.



The red line, of course, is the Relative HUI superimposed over the standard HUI bull-market-to-date graph.  Once again the 1.0 level represents times when the HUI traded at its 200dma, above 1.0 when the HUI traded above its 200dma, and below 1.0 when the HUI traded below its 200dma.  Some interesting insights instantly emerge that were not apparent in the standard graph discussed above.


While today’s Relative HUI reading around 1.4 is on the high side of normal (the average Relative HUI since 2001 is 1.19), it is nowhere close to extreme yet.  In both the 2001 and 2002 major gold-stock uplegs, the Relative HUI rocketed far above today’s 1.4 levels in the final-stage blowoffs marking the end of each respective upleg and the beginning of the healthy overbought PM-stock corrections.


In 2001 the Relative HUI pushed 1.6 and in late spring 2002 it soared above 1.8, meaning that the HUI was incredibly trading 80%+ higher than its 200dma!  At this stage in the young gold-stock bull today, there has been no major HUI upleg that has failed yet when the HUI was merely trading around today’s relative levels, about 40% above its crucial long-term 200-day moving average.


So while we are finally starting to push relative highness in terms of the Relative HUI this week, there are certainly as of yet no overwhelmingly dangerous signals being flashed by this particular indicator.  As the last two major gold uplegs had an average top when the Relative HUI was around 1.7 or so, odds are we can at least hit 1.5 or 1.6 on this particular gold-stock upleg today before the Relative HUI starts throwing off short-term warning signals for PM-stock speculators to consider.


And moving forward, it is really provocative to note that no HUI rally, either major or minor, seemed to ever fail before a Relative HUI reading of 1.2 was obtained.  The two minor rallies in late 2002 for example, while not as spectacular as the major uplegs, didn’t nose over and correct until the Relative HUI hit 1.37 and 1.26 respectively before they gave up their short-term ghosts.  As such, I view any Relative HUI reading below 1.2 or so as a “safe zone”, where investors and speculators can generally purchase PM stocks at will and not have to worry too much about an imminent HUI correction.


And anytime the Relative HUI actually plunges below 1.0, when the HUI effectively submerges below its 200dma, this is a major strong buy signal in Relative HUI terms!  You will note above that anytime sub-Relative-HUI-1.0 levels were witnessed a strong gold-stock rally ensued shortly afterwards.  In any secular bull market there is no better time to buy than when the market index trades under its 200dma temporarily.


So trading the Relative HUI is quite easy.  You can calculate it anytime by dividing the actual HUI close by its 200dma as of that particular trading day.  If you happen to witness a Relative HUI under 1.0, it is a strong and immediate buy.  If you want to deploy any more speculative (or even long-term investment) capital into PM stocks, this sub-1.0 zone is the time to do it!  Be patient and vigilantly watch for these golden opportunities!


This buy zone runs up to 1.2 or so, fading on the way up.  While 1.0 or less is a strong buy, a Relative HUI approaching 1.2 is still a moderate buy but much less attractive since minor gold-stock uplegs sometimes fail not too far above 1.2.  Once the Relative HUI exceeds 1.2 however, it becomes more of a long neutral hold, with no clear advantage between buying or selling PM stocks in Relative HUI terms.


After that, outstanding PM trades can probably be held without reservation until a Relative HUI reading of 1.5 to 1.6 or so is witnessed.  Once these levels above 1.5ish are reached, the PM speculator ought to consider either selling his trading positions outright or raising his trailing stops to minimize his profits lost when the inevitable HUI pullback arrives.


So how does all this Relative HUI mumbo jumbo work in real life?  Well, thankfully not too shabby so far!


Both of our private newsletters that we publish at Zeal for our dear subscribers, the monthly Zeal Intelligence and the anytime Zeal Speculator, purchased official gold-stock positions near the last sub-1.0 Relative HUI lows achieved late in the first quarter of this year.  The actual Relative HUI low this spring proved to be 0.9 on March 27th, deep into the strong-buy zone.


The monthly Zeal Intelligence PM stock picks were purchased a few days later at month-end.  As of the middle of this week, our clients and we were blessed with actual average unrealized gains of +56% across the five PM stocks we bought near the late March Relative HUI low. 


In the anytime Zeal Speculator, we were able to buy intra-month at even more advantageous prices a week before the final Relative HUI interim low of late March.  Our ZS actual average unrealized gains as of this week were running +72% in these very five elite unhedged gold and silver stocks, which was certainly wonderful to behold.  Yes, this young gold bull market is amazing and a lot of fun!


The bottom line is that the Relative HUI can be a useful addition to any gold speculator’s, or even investor’s, arsenal of technical trading weapons.  While we have been monitoring it privately since spring, I am going to start integrating it into our two newsletters to keep our subscribers abreast of what this indicator is telling us about the relative price level of the crucial HUI.  We will continue diligently using this and other indicators in our perpetual attempts to try and execute superior PM-stock trades in real-time for our subscribers.


While absolute index levels like HUI 200 are exciting and psychologically important, even more insight can be gleaned by relativizing the absolute HUI relative to its strong 200dma.  And today, even though the Relative HUI is marching relentlessly higher, it still does not look grossly overbought in light of its bull-market-to-date precedent.  Odds are the gold stocks still have room to run yet in this upleg!


Adam Hamilton, CPA     September 12, 2003     Subscribe