Big HUI Daily Moves

By Adam Hamilton

For precious-metals stock traders, weathering outsized volatility is a fact of life. Yet again over the last few weeks this truth was really driven home. The flagship HUI gold-stock index experienced some neck-snapping swings. And this generated much angst for those not yet steeled against such extreme volatility.

While long-term investors shouldn’t care one bit, big swings can be very perilous for speculators. These big daily moves tend to generate intense levels of greed or fear. And these emotions are the mortal enemies of all speculators, the primary challenge that must be overcome if one is to succeed in trading.

So anything that can mitigate the emotional impact of big daily swings is very valuable. For me, the best way to move towards total emotional neutrality regardless of volatility is to diligently study the markets. As I learn, my expectations are more properly aligned with probable outcomes. And something that is expected, even if it is a low-probability event, is vastly less startling than something totally unexpected.

Buffeted by the extreme HUI volatility lately like all PM-stock traders, this week I wanted to deepen my knowledge of this phenomenon. The more we understand past HUI behavior, the less surprised we are likely to be by future HUI behavior. The goal is to be emotionally immune to whatever the HUI decides to throw at us.

A year ago my business partner Scott Wright wrote an excellent essay on the biggest daily gains within massive HUI uplegs. I want to build on his research work using an approach similar to what I used a few weeks ago to analyze big daily moves in the S&P 500. It involves looking at both big up and down days in the HUI over many years to gain an understanding of their magnitude, frequency, timing, and likelihood.

The HUI is in a secular bull market. It stealthily launched from humble origins in mid-November 2000 and has climbed 1331% at best on a closing basis as of mid-March 2008. Since I am most interested in big HUI daily moves within this bull, I ran this study back to 2000. Out of curiosity, I included that whole calendar year too. In the general stock markets, big daily moves are much more common in bear than bull.

To start, I plotted the HUI’s biggest daily moves on its long-term price chart. The top 12 largest gaining days and the top 12 biggest losing days are noted below. This was quite interesting, as it offers insights into big HUI daily moves’ magnitude, frequency, and timing. As expected, to rate as a big swing in the HUI a day has to be off-the-charts volatile by the standards of almost any other sector.

A few weeks ago while analyzing the S&P 500, I found its top 12 daily rallies and declines of the past decade averaged swings of +4.6% and -4.3%. Such swings wouldn’t even register on the HUI’s big daily moves list! Not surprisingly this small speculative sector is radically more volatile than the general stock markets. The HUI’s top 12 daily rallies averaged 9.7% gains while its worst 12 days averaged 8.2% losses!

The clustering of these big days is pretty interesting. Note that the great majority of the biggest HUI daily rallies occurred in this bull’s initial couple years. Another two, including the biggest one at a massive 15.8%, emerged late in the secular bear in 2000. This makes sense, as the PM stocks’ collective market capitalization was so tiny back then that it didn’t take much buying or selling to drive serious swings.

The highest frequency of big up days happened near the end of the HUI’s first major upleg that ended way back in late May 2001. We are talking multiple 10%+ days here, a truly remarkable and wonderful time for PM-stock traders that I remember well. Back then contrarians were considered lunatics by mainstreamers so it was very nice to earn big gains while their tech stocks ground lower in a nasty bear.

Provocatively, 5 of the top 12 biggest daily gains happened in Mays with 2 more in early Junes. No other time of the year even came close in terms of seasonal frequency of big gains. So if you are big-gain hunting in the HUI, your best bet is to look for massive HUI uplegs maturing in late spring. This dovetails in perfectly with what is expected this year, as I discussed recently in an essay on HUI seasonals.

The HUI’s biggest daily losses since 2000 are much more spread out than its gains. Nevertheless, we’ve seen a clustering of big daily losses in the last couple years or so. This is logical too. As a sector bull matures, outsized gains and losses grow asymmetrical. Greed builds slowly over time, generating modest but consistent gains. But as we saw last month, fear flares up in heartbeat. This drives fast selling.

It is far easier for the sudden and very potent emotion of fear to spawn serious selling in a single day than it is for greed to reach a fever pitch in a single day. This becomes even more true the larger a sector grows. The bigger its collective market cap and the more traders participating, the less likely the majority will get greedy on the same day and bid aggressively enough to move the larger stocks sharply higher.

Interestingly March 19th, 2008’s brutal 6.9% plunge proved to be the HUI’s 9th largest down day since 2000. So if you were feeling sick that day, you had good reason to. Daily declines of such a brutal magnitude are very rare even within the volatile PM-stock sector. Thankfully we don’t have to weather such dreadful events all that often. They can exact tremendous psychological tolls.

While I found this first chart interesting, it didn’t quite offer the resolution I was looking for. It is already getting busy in places visually yet I’d barely scratched the surface of big HUI days. I’ve been trading PM stocks for this entire bull, and have watched the HUI every day for most of it (in the early days the XAU was a more popular index). Over 7+ years I developed some definite notions about HUI volatility.

To me, any sub-2% swing in the HUI is random noise, irrelevant. It happens so often it isn’t even worth thinking about. Around 3% on any given day, and the HUI starts to get interesting. Usually some catalytic move in gold is necessary to drive such a swing. But the really exciting HUI days are the 4%+ ones in either direction. They are rare and meaningful enough to warrant serious analytical consideration.

But these 4%+ HUI days are also still numerous enough to overwhelm the approach above to plotting them. So I built a different type of chart to observe their magnitude, frequency, and timing. All 4%+ daily swings are rendered here, with the heights of the red bars recording their individual sizes. Any sub-4% daily moves are simply not charted, as they’d make this graph far too busy.

Big HUI daily moves of 4%+ in either direction were much more common during the PM stocks’ early tiny-market-cap years. The clusters of red columns are not only denser pre-2004, but they tend to have larger average magnitudes than what we’ve seen since 2004. The smaller a sector and the fewer traders gaming it, the easier prevailing sentiment can aggressively push it around.

But since the pre-2004 HUI bull feels like ancient history now, I’d like to focus on the last several years. Since we just weathered a massive down day in March, they are a good place to start. Interestingly the big HUI down days are fairly rare and well-dispersed. The only times they have tightly clustered is in the necessary corrections following major uplegs. Steep fear-driven selloffs are par for the course after big uplegs.

But seemingly random big selloff days happen from time to time too, totally outside of post-upleg corrections. During the long consolidations in early 2005 and again in late 2006 and 2007, the HUI did periodically plunge by 4%+. Although scary in real-time on the days they happened, it is really interesting that these quasi-random big down days never altered the HUI’s primary trend.

If a 4%+ plunge happened during an upleg, such as in early 2006, it didn’t end that upleg prematurely. If it happened in a consolidation, like in early 2007, it didn’t knock the HUI out of its consolidation range. This proved true even of the massive 7%+ plunges. They would emerge out of the blue, spark intense fear, and then the HUI would continue on its merry way as if they had never happened. This is very relevant to today.

Some analysts believe the HUI now has to be in correction mode since it plunged 6.9% on March 19th. Surely such big down days are only major-correction events, right? Definitely not. On February 7th, 2006, the HUI plummeted 7.9% (5th largest down day) to 315. Yet that massive upleg would ultimately climb to 394 before topping in May. Obviously that isolated February selloff didn’t short-circuit the in-progress upleg.

A similar event happened this past November. On November 12th, 2007, the HUI plunged by 7.6% (6th biggest). Calls for a major PM-stock correction grew universal. A lot of folks understandably believe that such selloffs can only happen after upleg-ending major highs. But history refutes this false notion. The HUI would soon start rallying again from 408 that day to 515 in March 2008. This upleg wasn’t damaged.

In light of this precedent, the big March 19th, 2008 selloff shouldn’t worry traders a bit. It was fairly isolated, as there was no big cluster of 4%+ down days like we tend to see in major corrections. And isolated big-selloff days simply rapidly bleed off greed before the HUI continues on in its prevailing trend. Also, the lack of clustered 4%+ down days suggests March was not a major interim top!

Big 4%+ up days also happen periodically as this chart reveals. They are actually more frequent than the big 4%+ down days, although their average magnitude is not as great. They tend to crop up every few weeks or so during in-progress major uplegs. It is interesting that their distribution in the huge 2006 HUI upleg was similar to what we’ve seen in our current upleg. This suggests our current upleg will indeed prove massive too.

Pondering this chart yields a couple of key strategic observations that will certainly help me weather future outsized HUI volatility. First, 4%+ swings in this index in both directions are not too uncommon. Knowing this, there is no reason to let them generate excessive greed or fear in our hearts when they happen. PM stocks have always been and probably will always be an exceptionally volatile sector. We have to live with that.

Second, outside of the primary exception of clustered big down days in major corrections, big HUI daily moves generally don’t alter the prevailing tactical trend in force. If the HUI is correcting, a big up or down day isn’t going to alter this necessary sentiment rebalancing. If it is consolidating, it will continue consolidating right on through big daily swings. And if it is rallying in an upleg, even isolated extreme daily losses don’t jeopardize this uptrend.

So as PM-stock traders we need to chill out and relax when big daily moves are witnessed. As often as they occur, there is no reason not to be coldly rational and emotionally neutral on them. While big moves in both directions can wreak havoc on stop losses, we have no choice but to accept their periodic appearances. PM stocks are a high-risk high-reward sector, and big daily swings are one of these risks.

I built one final chart to map the probabilities distribution of big HUI daily moves. Just how rare is a 7% down day, or a 5%+ up day? It would be nice to know in the future exactly how special a big day is relative to the HUI’s past behavior in this bull. Having this information really helps to properly set expectations and moderate the emotional impact of similar big days in the future.

The population size here is the 2073 trading days between January 1st, 2000 and April 1st, 2008. The green and red numbers are discrete probabilities. For example, the odds of the HUI rising between 3.00% and 3.99% on any given trading day have been 5.0% so far in this bull. The yellow numbers are cumulative probabilities. The odds of a 4% or greater down day in the HUI are 4.0%. For lower-probability moves, the absolute number of days they have happened since 2000 is also noted in white.

Surely my old college statistics professors would be proud of these results, a pretty normal bell-curve type of distribution like virtually everything else in the universe. It is positively skewed, reflecting the HUI’s secular bull. Its tails are only slightly fat, showing that massive 10%+ moves are exceedingly rare. All kinds of interesting probability analyses governing the likelihood of big HUI daily moves emerge out of this distribution.

On the cumulative front, only 50.3% of the HUI days were positive despite this index being in an utterly massive 1331% secular bull market! A lot of naïve PM-stock traders get antsy whenever the HUI isn’t advancing every single day. But a bull market is a rise on balance, not an endless chain of up days. Day to day, random noise colors HUI performance far more than prevailing secular or tactical trends.

Such a huge bull with only slightly more than half of its days rising offers an interesting trading corollary. All traders have losing trades, they are as inevitable as down days. Yet if you can win on balance, and keep your average wins bigger than your average losses, you will have no problem growing wealthy in the markets over time. It is one giant probabilities game where tilting the odds slightly in your favor yields enormous ultimate gains. PM-stock traders worried about losses would do well to remember this.

Interestingly the flat HUI days, less than 1% in either direction, are actually negatively skewed despite the HUI’s strong bull market. A sub-1% negative day has a 16.2% chance of occurring while a sub-1% positive day only has a 15.9% chance. At 1%, this negative bias still exists at 14.9% down and 13.0% up. So perhaps the HUI has a tendency to drift lower on days when excitement is low and nothing interesting is going on.

But the farther out we venture towards the tails of this distribution, the more positively-skewed it gets reflecting the HUI’s bull-market tendency to rise on balance. This is especially apparent in the yellow cumulative-probability stats. The HUI has a 21.3% chance of moving up 2%+ on any given day but only an 18.7% chance of falling by 2%+. At 3%+ this divergence grows to an 11.3% chance positive and a 9.1% chance negative.

After that this bull-market positive skew really becomes apparent at those big 4%+ days. The odds of the HUI rallying 4.00% to 4.99% on any given day are 2.9%, while its odds of falling the same amount are only 2.4%. In cumulative terms, the HUI has a 6.3% chance of rallying 4%+ but only a 4.0% chance of falling 4%+ on any given day. And this positive skewing holds the deeper into the tails we venture.

Stepping back a bit, a 4%+ swing in the HUI is really not all that rare. We are talking a 10.3% cumulative chance in both directions. Thus, on average, on 1 out of every 10 trading days in the HUI we are likely to see this index move by 4%+ in either direction. This is once every two weeks! In the far-less volatile and far-less speculative S&P 500 the odds of such a 4%+ swing are just 0.6%, 17.2x less than the HUI’s!

With such high odds of sharp daily moves in the HUI, they really shouldn’t excite PM-stock traders all that much. We all willingly choose to risk our hard-earned capital in this highly volatile high-potential sector, no one holds a gun to our heads. So when its perpetual high volatility manifests itself on a particular day, we should shrug, enjoy the show, and refuse to let greed or fear well up in our own hearts.

At Zeal, we continually study the markets to try and purge ourselves of greed and fear. Meticulous research yields coldly rational trades that win on balance, growing our wealth. You can join us, using our research to keep your own destructive emotions in check and multiply your capital in these commodities bulls. Subscribe today to our acclaimed monthly newsletter and learn to trade commodities stocks without emotion when probabilities for success swing in your favor.

On PM stocks specifically, the sharp fear-driven HUI selloff in mid-March really hammered the beaten-down junior gold stocks. But as this research shows, such isolated selling days don’t alter prevailing trends. So this HUI upleg likely remains alive and well, meaning higher highs are probable. The irrationally-hated juniors should greatly amplify the HUI’s gains. We recently published a new report on our favorite 12 high-potential junior gold stocks. Buy it today to take advantage of the junior-gold fire sale!

The bottom line is PM-stock traders simply need to expect outsized volatility. The big 4%+ daily moves that can spawn excessive greed or fear are simply not uncommon in this still-small sector. It is pointless to get worked up about them, especially since isolated big HUI daily moves almost never mark a tactical trend change. The HUI just continues on its merry way after it shakes traders with its exceptional volatility.

Adam Hamilton, CPA

April 4, 2008

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