Hedging Gold's Volatility

Includes: AGT-OLD, EGO, GBN, HL, NG, NGD
by: Hard Assets Investor

By Brad Zigler

I presented a hedging strategy for gold mining stock buyers at the recent Hard Assets Conference in New York.

By request, here are highlights of the presentation:

Gold Stocks Do Not Equal Gold

Gold bullion and gold mining stocks, while closely correlated, do not move in lockstep with one another. Sometimes gold moves faster; at other times, stocks do.

  • AU = PHLX Gold/Silver Index
    • 16 US-traded mining stocks
  • Bullion
    • London AM Gold Fix (in $US)

Gold mining stocks can be collectively monitored through indexes such as the Philadelphia Stock Exchange's Gold/Silver Index (XAU). The benchmark for gold bullion pricing has long been the daily price fixing through the London Bullion Market Association.

May 05 - Jan 06 Returns Jan 08 - Mar 08 Returns
  • XAU +73.6%
  • XAU - 7.5%
  • Bullion +26.0%
  • Bullion +13.8%

As an example of the disparity in gold and mining stock prices, look at the returns earned by XAU and London gold between May 2005 and January 2006. Propelled by an ebullient equities market, gold stocks ran up nearly 74% though bullion appreciated only 26%. The opposite condition prevailed in this year's first quarter as stocks sold off against a rising bullion market.

Why Buy Gold Stocks?

  • Capture value of management
    • Company/companies "better" than peers?
  • Capture gold exposure
    • Why not just own bullion?

The essential question you should address when considering gold mining stocks is this: What do you hope to gain through the stock investment that you couldn't get from owning gold itself? If you want to capture gold's price movement, there are now low-cost and transparent means to gain gold exposure without also taking on equity risk. If you opt for mining stocks instead, your choice should be based upon your willingness to accept and exploit the risk of investing in a particular company's management.

Professional Strategy

Isolate stock "alpha" (management value)


Suppressing gold "beta" (risk)

Professional investors describe the return earned over a market benchmark's as "alpha." The market return is represented as "beta." We can adapt those terms to our gold mining investment model by ascribing the return earned by a firm's management as "alpha," while the return earned from gold itself is deemed "beta."

Relative Values


  • Usually small
  • Can be large
  • Usually expensive
  • Usually cheap

Alpha is not easily obtained in any market and tends to be incremental. Beta, on the other hand, is readily available through low-cost index products.


Split risk capital between alpha and beta

  • Half to gold stock(s) or fund
  • Half to double short gold ETN

We can isolate the management value of a gold mining stock (or a fund of gold mining stocks) by coupling long exposure in the stock with short exposure to gold. The mining company's management skill can then be distinguished from the vagaries of the gold market. If, for example, you originally decided to commit $40,000 of risk capital to gold mining stocks, you might instead put only $20,000 into the stock (or fund) and use the rest of your capital to buy exchange-traded notes that simulate a leveraged short position in a gold futures index.

What's an ETN?

  • Zero-coupon debt obligation
  • Value tied to index of gold futures
  • Can offer short or long exposure
  • Can offer 100% or 200% exposure

An exchange-traded note is a debt security issued by a commercial or investment bank. Rather than paying interest, the note's value is adjusted for changes in its underlying index. The note can track the index directly (long) or inversely (short) as well as providing unleveraged (100%) or leveraged (200%) exposure.

Double Short ETN

  • Issued by Deutsche Bank (London)
  • Tracks 2x DB Gold Index - Optimum Yield
  • Ticker symbol DZZ

The specific note to employ in our isolation exercise is the DB Gold Double Short ETN, under ticker symbol DZZ.

Sample Gold Stocks

  • Hecla Mining (NYSE:HL)
  • Great Basin Gold (GBN)
  • El Dorado Gold (NYSE:EGO)
  • New Gold Inc (NYSEMKT:NGD)
  • NovaGold Res (NYSEMKT:NG)

To test our hedge hypothesis, we'll pit the DZZ note against long positions in these Hard Assets Conference exhibitors.

Unhedged Stocks (28 Feb - 9 May)




Hecla Mining (HL)




El Dorado Gold (EGO)




NovaGold Resources (NG)




Great Basin Gold (GBN)




New Gold Inc (NGD)




Apollo Gold Corp (AGT-OLD)












Since the launch date of the DZZ note, these stocks lost, on average, more than 3% while cranking out an average volatility of 62%.

Hedge Ratios

[Portfolio Value ($) x
Hedge Ratio] ÷
Average DZZ Price


[$20,000 x 1.11] ÷ $26.83 =
827 DZZ notes

Hedge Ratios

  • HL = 1.11
  • EGO = 1.16
  • NG = 1.08
  • GBN = 1.16
  • NGD = 0.89
  • AGT = 1.70

To determine the proper number of notes needed to hedge each issue, the quotient of the stock's and DZZ's volatilities is used as a hedge ratio. The hedge ratio is first multiplied by the size of the stock position with the product then divided by the note's average market price. Hedging a $20,000 Hecla (HL) position, as an example, can be accomplished with a complementary position made up of 827 DZZ notes.

Hedged Stocks (28 Feb - 9 May)

Return Volatility


Hecla Mining (HL) 4.6% 22.8% 0.20
El Dorado Gold (EGO) 14.4% 30.1% 0.48
NovaGold Resources (NG) -6.6% 25.8%


Great Basin Gold (GBN) 5.8% 28.6% 0.20
New Gold Inc (NGD) 22.5% 28.2% 0.80
Apollo Gold Corp (AGT-OLD) 7.9% 36.8% 0.21
Mean 8.1% 28.7% 0.27
Median 6.9% 28.4% 0.21

Hedged, the stocks returned an average 8% for the period, with a volatility of only 29%.


Return Volatility Reward-to-Risk
Hecla Mining (HL) 15.2% -35.1% 0.38
El Dorado Gold (EGO) 5.5% -30.5% 0.33
NovaGold Resources (NG) 25.7% -30.2% 0.32
Great Basin Gold (GBN) 14.7% -31.9% 0.35
New Gold Inc (NGD) -2.3% -18.1% 0.26
Apollo Gold Corp (AGT-OLD) 9.5% -51.7% 0.23
Mean 7.8% -24.8% 0.22
Median 7.4% -29.3% 0.22

In all but one instance, the DZZ hedge would have improved returns for the mining stocks. Average return improved nearly 8% while volatility was significantly reduced. Overall, the reward-to-risk ratios for these half-dozen stocks improved twelvefold.

Hedging (6) Stocks as a Portfolio

Unhedged portfolio
return -6.6%

return +20.0%

Hedged portfolio
return +4.8%

If the six stocks were combined into a portfolio, periodically rebalanced, DZZ could have hedged a nearly 7% loss to allow the emergence of an aggregate 4.8% alpha.

Hedging Broader Portfolios

Market Vectors Gold Miners Fund (GDX)

  • 34 Components
  • Hedge ratio 0.83
  • Unhedged return -15.5%
  • Hedged return +0.4%

A broader-based portfolio, accessible through a mutual fund or an exchange-traded fund can also be utilized in the strategy. Here, the Market Vectors Gold Miners ETF's (AMEX: GDX) period loss of more than 15% was neutralized by DZZ.


  • Hedging with ETNs
    • Quantifies management alpha
    • Useful on a macro or micro basis
    • Dampens volatility and drawdown risk
    • Enhances "staying power"

Combining ETNs with gold equities allows investors to quantify company management's bottom-line contribution. The hedge can be used against individual issues or portfolios either assembled by the investor or professionally managed. Volatility is reduced and staying power enhanced through selective hedging.

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