Follow-up No. 9 / August 11, 2008

AMEX's Gold BUGS Index (HUI) and the Philadelphia Stock Exchange's XAU

Overview

Two major gold indices dominate the market - the AMEX's Gold BUGS Index (HUI) and the Philadelphia Stock Exchange's XAU

The major difference between the two is that the BUGS index is made up exclusively of mining stocks that do not hedge their gold positions more than a year-and-a-half into the future. This makes the BUGS Index much more profitable than the XAU when gold prices are rising, but can also compound its losses when gold declines. BUGS is an acronym for Basket of Unhedged Gold Stocks. The index was introduced on March 15, 1996 with a starting value of 200.

Positives

When gold prices are on the rise, the Gold BUGS Index provides an excellent way for investors to capitalize on that increase. The index has a high correlation to the spot price (current price) of gold.

Drawbacks

When the price of gold declines, the Gold BUGS Index tends to fall much faster than its hedged cousin, the XAU. In addition, the firm's unusual index weighting system can be difficult to understand.

Composition

The AMEX Gold BUGS Index is comprised of 15 of the nation's largest "unhedged" gold mining stocks. It is a "modified equal-dollar weighted" index. As a result, most of the index's component stocks are equally weighted, yet the largest stocks still carry a greater weight than the smallest.

The table below lists the components of the Gold BUGS Index along with the weighting that each stock carries in the index (data as of August 2004):

After the introduction of the HUI in 1996, gold outperformed the major gold shares until 2001 as those companies were increasingly unable to generate profits. In 2001 the bull market in precious metals started and the gold shares recovered in a spectacular way as they managed to generate profits again due to the higher metal prices.

Since 2006, gold has outperformed gold shares again in spite of the fact that these companies generate spectacular earning increases. Newmont Mining's earnings per share for example are expected to increase 80% in 2008 and 25% in 2009.

Major gold shares are definitely undervalued in relation to the gold price at present.

The Case of the Junior Mining Companies

Since 2002, the Gold Bugs Index (HUI) went through five major corrections which reached between 30 and 40%. The four corrections from 2002 to 2008 were followed by impressive price surges exceeding 100% twice.

At present, the Index is down 31% which is a bit less than the figures obtained during the four preceding corrections. But if past market action can be any guide to the future, we can conclude that the next upswing could get under way anytime.

The period September / December has traditionally been good for precious metal stocks. Above chart also demonstrates that the low point has often been reached during the summer months.

The Gold Miners Index shows a similar pattern as the HUI. Corrections of 30% have been followed by price increases up to 100% and more.

The Index is off from the high reached early in the year by 32% thus matching the average corrections which have preceded this one.

Here again, if the past is a guide to the future, we have reached a compelling buy level. While these are technical considerations, fundamentals also support the believe that a sharp rally should not be far off.

Alamos Gold e.g. just came out with record production and earning figures for Q1 2008 with a cash cost of $ 361 per ounce of gold produced.

Most components of the GOLD BUGS INDEX show an estimated strong earnings growth in 2008, mostly close to 100% or exceeding this number by most analysts who cover these companies.

More earnings growth is estimated for 2009, depending of course of the level of precious metal prices and also to what extent production costs will rise.

While the major gold stocks fared fairly well during the first half of 2008 but still underperformed the metal. In July the majors went through a heavy correction like e.g. Agnico Eagle which fell from $ 80 to $50 or 35%.

THE TIMELESS PRECIOUS METAL FUND AND THE SIERRA MADRE GOLD & SILVER VENTURE FUND are excellent possibilities to participate in the coming rally of the juniors.

For those however who prefer to have their individually managed precious metals portfolios we also offer Portfolio Management services (www.pzim.com).

Above recommendations were valid at the time of writing, viz. at

and may no longer be pertinent when you read them.

Disclaimer: P. ZIHLMANN INVESTMENT MANAGEMENT AG does not accept any liability for any loss or damage whatsoever, that may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in the trading recommendations or in any accompanying chart analyses, whether communicated by word, or message, typed or spoken by any of its employees.