Gold BUGS Index
Overview: Two major gold indices dominate the market–the Philadelphia Stock Exchange’s XAU and the AMEX’s Gold BUGS Index (HUI). The major difference between the two is that the BUGS index is made up exclusively of mining stocks that do not hedge their gold positions more than a year-and-a-half into the future. This makes the BUGS Index much more profitable than the XAU when gold prices are rising, but can also compound its losses when gold declines. BUGS is an acronym for Basket of Unhedged Gold Stocks. The index was introduced on March 15, 1996 with a starting value of 200.
Composition: The AMEX Gold BUGS Index is comprised of 15 of the nation’s largest “unhedged” gold mining stocks. It is a “modified equal-dollar weighted” index. As a result, most of the index’s component stocks are equally weighted, yet the largest stocks still carry a greater weight than the smallest.
Positives: When gold prices are on the rise, the Gold BUGS Index provides an excellent way for investors to capitalize on that increase. The index has a high correlation to the spot price (current price) of gold.
Drawbacks: When the price of gold declines, the Gold BUGS Index tends to fall much faster than its hedged cousin, the XAU. In addition, the firm’s unusual index weighting system can be difficult to understand.
Simple hedging HUI/GOLD: The value of the HUI index is fundamentally based on the price of gold, everything else is just noise. One should be able to determine a theoretical “correct value” for the HUI index, depending solely on a ratio of the HUI to the price of gold. Any advance in the HUI index far above an idealized HUI/gold ratio should be sold. Any decline of the HUI index far below the HUI/gold ratio should be bought.