The XAU versus the SPX
Philadelphia's Gold & Silver Index versus the Standard & Poor's 500 Index
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The XAU versus the SPXPhiladelphia's Gold & Silver Index versus the Standard & Poor's 500 Index |
Below are charts that explore how different formulas affect the presentation of prices.
The chart below displays the XAU along with three component issues in the index. These three stocks were selected simply because these are the only stocks remaining from the original nine when the index was first reported back in Jan. 1979. In addition, the daily average of the AM/PM London Gold Fixings is plotted. I was curious to see how closely the index matched these three stocks performance. The XAU is a capitalization weighted index and as of 8/22/03, NEM is the largest component of the XAU with a 25.77% weighting. ABX comes in at number two with a weighting of 16.84% and PDG is number five with a weighting of 9.04%. This means the XAU strongly tracks NEM's and ABX's movements.
As you can see, the XAU is rising as is NEM but ABX and PDG aren't making commensurate moves. Also note how gold and stock prices don't match at times. So I wondered how the percentage changes in these stocks compare to the XAU's percent changes.
Below is a chart that illustrates the effect of summing daily percent changes. The reason for converting prices into percent changes was because from the investor's point of view, this is what counts. If you invest your money, you are looking at the return on investment. Of course, you're looking to make a million dollars, but professionals always consider how much money they made and how long it took to make it. So when an investment provides the investor with a 100% return, they will usually cash out. They know that making 100% isn't easy, and more importantly, keeping it is even harder. (How many times have you seen profits evaporate?)
If you take this at face value, this chart shows you that these investments are making enormous gains. Since Dec. 2000, they moved from -0.8 to +0.2 to +0.5. So they moved from -20% to +20% to +50%. That's a 40% to 70% increase in value. In addition, if you look at the chart it even states that these investments have gained from the starting point back on 6/3/96. But this doesn't display the same story as the chart above, in which prices clearly are lower than from where they started. Also note that the gold stocks percentage increase is faster than the percentage increase in gold. So what's wrong?
This is a common misconception to apply this formula to a time series. If somebody wanted to sell you something, which picture would you use? The true prices tell the real story, but this daily percent chart also tells a story. The problem is that when ratios are added they don't represent the same relative difference. For example, a $2 drop on a $50 stock is a 4% decline but when the same stock is now priced at $40, a $2 drop is a 5% decline. When the same stock gets to $20, a $2 drop is now a 10% decline. So you see, these percent changes are correct, but they're relative to the current price.
Adding ratios is routine in the business world and it has its place, even in the example below it has merit. It shows you that since Dec. 2000 these gold stocks have made big percentage gains. But that's all it is telling you. You can't read into this chart that these investments are performing better than they did back in 1996 because they're not! This is simply a mathematical illusion due to the misapplication of ratios.
So there are two views thus far and each one looks different. Prices look flat but daily percent changes look great. But the question an as investor is how do these gold stocks measure up against other stocks, or the stock market as a whole. Well, below is a chart that shows you exactly how these gold stocks compare to the SP500 index. This third view tells yet another story.
The method for computing these relative percent changes is different than in the graph above. In the graph above, the daily percent was calculated by dividing today's closing price with yesterday's, andthese ratios were simply added together. In the graph below, the closing price on 6/3/96 was used a base and all subsequent closing prices were divided by the 6/3/96 prices. Doing this now compares the change from each of the investments and is expressed as a ratio relative to a specific price. This is a valid use of ratios.
As you can see, this shows a totally different view of the investments. As for the gold stocks and the XAU, they still haven't return back to 0, or their original prices set back in 1996 while the SP500 is still above its 1996 prices. This is completely opposite to the story that the graph above displayed. What's more remarkable is that gold stocks couldn't rise above their 1996 prices amidst all of the global chaos and financial malfeasance that occurred since then. As an investor this is disturbing since one would need to ask if the Russian crisis of 1998 didn't make investors run for cover; and if the World Trading Center collapse didn't scare investors; and if the demise of Enron, MCI Worldcom, Tyco, Arthur Anderson, Sunbeam, and other conglomerates didn't scare investors into gold, then what will? Also note that the price of gold has been relatively stronger than gold stocks, which is again opposite to the story displayed above.
Stock investors from 1996 are theoretically still in profits (don't ask investors of Enron, MCI Worldcom, Tyco, Sun Microsystems, and many other technology shareholders) while gold investors are still losing. If you look at the chart from left to right, you can see that as the SP500 rose, gold stocks declined. The gold stocks even declined at the 2000 market top. If you look carefully, you'll see that the gold stocks declined from June 2000 to Dec. 2000. It was during this time that both the SP500 and gold moved together, when in the past they moved in opposite directions. After that, the XAU started to slowly make its ascent. However despite this meager ascent, the SP500's decline dwarf's the magnitude of the rise in the gold stocks.
Besides illustrating how different formulas create different views, here's another reason why this graph was created. It was created to see if investors "jumped ship". The question asked was "did investors move their money from the broad market to the gold sector and would this affect prices"? Well, as you can see, investors only started to invest in the gold sector when the market broke the lows back in June 2002. In addition, you can see that gold stock prices spiked as the SP500 dropped. And if you look back in time, you'll see several spikes in the gold stocks whenever the SP500 drops. You can plainly see that there are investors out there that shift their money from the broad market to the gold sector when prices drop. However, since the Spring of 2003, both the SP500 and gold stocks are rising commensurately. This underscores that something has changed.
These charts depicted above each tell a story but also serve to illustrate how easily facts can be manipulated. In the first graph, the XAU is telling investors that gold stocks are rising but prices are still at depressed levels from 1996. In graph 2, gold stocks appear to be flat but are making large percentage gains. And in graph 3, the broad market is still above 1996 levels yielding profits for long term investors while shareholders in gold stocks are waiting to break even. And lastly, both the SP500 and gold stocks are rising signaling a change in the perception of investors.
Is this change in perception powerful enough send the SP500 even higher? Have the corporate excesses of the late 90s been squeezed out? Are investors satisfied with the increased transparency of stock options? In response to the government's reduction in the "double taxation" of dividends, are companies going to compete for investors and entice investors by sharing their profits? Did the government "goose" investors enough with lower tax rates on dividends to return to the stock market? Is inflation coming and pushing prices higher? These hopefully will be answered before the opportunity to make money has evaporated.
created 8/24/03, ©2003, The Small Investors Software Co. All rights reserved.