Investing in particular gold stocks gives exposure to movements in price of gold, but also to other factors affecting the gold mining industry, as well as company-specific strengths and weaknesses. This is why investors have to bear in mind the trends in the gold market as well as the mining industry, and wisely select appropriate stocks. One way to avoid the problem of selecting the promising shares (for instance for those that don’t have access to tools that would make the selection easier) is to invest in the index of gold mining companies.

There are several options available for investors, but the two most watched indices are: the NYSE Arca Gold BUGS (Basket of Unhedged Gold Stocks) Index (called the HUI Index) and Philadelphia Gold and Silver Index (called the XAU Index). The former is a modified equal dollar weighted index of 14 companies involved in gold mining which do not hedge their production beyond 1.5 years. It was developed in 1996 and is still traded on the NYSE. The XAU is a capitalization-weighted index of thirty precious metal mining companies that has been traded on the Philadelphia Stock Exchange since 1983. Another closely observed gold mining index is the NYSE Arca Gold Miners Index, which is a modified market capitalization weighted index comprised of precious metal mining companies. Its performance is tracked by the Market Vectors Gold Miners ETF, which – as an exchange-traded fund – is an interesting option for gaining exposure to gold miners.

There are three main differences between the HUI and XAU indexes. The former includes only gold miners who do not hedge their gold production beyond 18 months, while the latter consists of companies who use such hedging, and includes both gold and silver miners. Actually, the XAU Index also includes companies that mine other metals, such as copper, and for whom gold is only a byproduct. For example, Freeport McMoran is the largest component of the XAU Index (it makes up 8.45% of it), but its gold sales generate only 10% of the company’s revenues. Therefore, it seems that the XAU Index is a less reliable indicator of stocks’ sensitivity to movements in gold prices than the HUI Index.

Moreover, the indices attach different weights to particular companies. For example, the three largest companies constituting the HUI Index make up 40% of it, while the same companies amount to just 24% of the XAU Index. It means that the latter is more diversified and better reflects trends in medium-cup companies.

This is why there will be differences in indices’ performance. Indeed, as you can see in the chart below, although the two indices are positively correlated, the HUI Index is often slightly more sensitive to movements in gold prices than the XAU Index.

Chart 1: The price of gold (yellow line, left axis, London P.M. Fix), the HUI Index (green line, right axis), and the XAU Index (red line, right axis) from 1996 to 2016.