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Understanding Market Volatility
of the HUI is Key to Managing Expectations for Gold Stocks
and Mutual Funds.
 A
fundamental aspect of investing is deciding how much risk
and volatility you’re comfortable with, and then choosing
investments that fit into that comfort zone.
Generally speaking, the greater the volatility
of a given security, the higher its risk for the investor.
And the greater the risk you’re willing to take, the
greater the potential profits you could reap. So taking
the comparison to its logical conclusion, the greater the
volatility, the greater the potential profits and, of course,
the greater the potential losses.
Investors may find it difficult and time-consuming
to figure out which funds provide the optimal balance of
risk, volatility and reward, but it’s worth the effort.
Understanding the volatility and risks involved with the
markets is vitally important to maintain both your investments
and your emotional health. Chasing performance or trying
to guess tops and bottoms in share prices can be both emotionally
and financially draining.
Standard deviation, also known as “sigma,” is
a valuable statistical tool for gauging a fund’s volatility,
as it measures how much the fund’s returns vary from
their mean, or average, over a given period of time.
For most funds, returns will be within one
standard deviation (one sigma) of their mean (average) 68
percent of the time and within two standard deviations (two
sigma) of the mean 95 percent of the time. Returns fall
within three sigma 99 percent of the time.
You can see this basic concept in the bell-shaped
curve to the right. The straight line down from the highest
point on the curve is the mean return over the specified
time period. The area in blue is one sigma above and below
the mean. By adding the area in green, you have gone out
two sigma on either side of the mean. The yellow segments
expand the white area to three sigma.
As an investor, sigma can help you
understand the level of volatility to expect from a particular
investment. That knowledge allows you to manage your risk
and it keeps you from getting overly excited when your investment’s
ups and downs fall within its normal range. It can also
help you identify when to buy or sell a stock or a fund.
Let’s look at the Amex Gold BUGS
Index (HUI) as an example of how to use sigma.
Magnitude for 1 standard deviation (1 sigma*)
as of 6/14/06
| Index |
Weekly |
Monthly |
Quarterly |
| HUI |
4.77% |
9.96% |
17.79% |
| S&P500 |
2.05% |
4.18% |
6.89% |
* Sigma is the Greek notation for standard
deviation. Normally distributed random data series fall within
+1 sigma from the mean around 68% of the time.
Over the last five years as of 6/14/06, the
HUI has had a quarterly sigma of 17.79 percent. That means
if you marked each quarterly return for the last five years
on a graph, you could expect 68 percent of those marks to
be within 17.79 percent above or below the average (mean)
return. Ninety-five percent of those marks would predictably
fall within 35.58 percent above or below the mean return
because that’s two sigma.
A gain of 10 percent in a quarter might sound
exceptional for an investment, but for the HUI, that level
of return falls within the range of normal over the past
five years. Likewise, a quarterly drop of 10 percent can
sound scary, but if you know the sigma for the HUI, you
know that too is within its normal movement.
When is an index overbought or oversold?
Quarterly Standard Deviation Movement
of the HUI – 2001-2006 as of 6/14/06
You should pay closer attention when returns
fall outside one sigma during a specific time period, whether
that variance is positive or negative. If an index’s
performance rises more than one sigma, it could signal that
it is overbought, so you might consider selling or holding
off on buying. That’s because, statistically, there
is only a 16 percent chance that it will go higher. The
mechanics are reversed when a performance drops more than
one sigma. In that case, it suggests the index’s stocks
may be oversold, so you might consider buying or not selling
because the chance of further loss is only 16 percent.
Volatility eases over time.
Again, look at the sigma over the weekly,
monthly and quarterly time periods for the HUI. You can
see that the volatility is not linear. For instance, the
HUI has a weekly sigma of 4.77 percent, so one might think
that the monthly sigma should be four times higher because
there are four weeks in a month. But in reality, the monthly
sigma of 9.96 percent is a little more than double the weekly
figure. Likewise there are three months in a quarter, but
the quarterly sigma was less than double the monthly number.
Investor psychology suggests that investors
are more comfortable buying a stock after it has moved up
and are more willing to sell when it declines sharply. Many
investors use the 200 day and the 50 day moving average
to make their decisions, however, this simple process can
be problematic when the sectors are more volatile. We believe
it is wiser to use dollar-cost averaging and set limits
on exposure to any asset class and rebalance annually to
catch, not chase volatility.
Please consider carefully the fund’s
investment objectives, risks, charges and expenses. For
this and other important information, obtain a fund prospectus
by visiting www.usfunds.com or by calling 1-800-US-FUNDS
(1-800-873-8637). Read it carefully before investing. Distributed
by U.S. Global Brokerage, Inc.
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All opinions expressed and data provided are
subject to change without notice. Some of these opinions
may not be appropriate to every investor. Gold funds may
be susceptible to adverse economic, political or regulatory
developments due to concentrating in a single theme. The
price of gold is subject to substantial price fluctuations
over short periods of time and may be affected by unpredicted
international monetary and political policies. We suggest
investing no more than 3% to 5% of your portfolio in gold
or gold stocks. The AMEX Gold Bugs Index (HUI) is a modified
equal-dollar weighted index of companies involved in major
gold mining. The S&P 500 Stock Index is a widely recognized
capitalization-weighted index of 500 common stock prices
in U.S. companies.
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