Plunge in gold price puts a bad idea out of its misery

After volumes in the Hong Kong Mercantile Exchange's gold futures contracts collapsed, cessation of trading was a foregone conclusion

PUBLISHED : Monday, 20 May, 2013, 12:00am
UPDATED : Monday, 20 May, 2013, 4:18am

It looks as if the 20 per cent fall in the price of gold over the past six months has put the Hong Kong Mercantile Exchange out of its misery.

As speculators fled the precious metals markets, volumes in the exchange's two gold and silver futures contracts collapsed.

Last month, HKMEx's 32-ounce gold future turned over just 12,866 contracts. Based on the average gold price for the month, that means trading in the exchange's flagship contract was worth just US$614 million.

In contrast, in the same month, New York's Comex exchange traded 5.2 million 100-ounce contracts worth some US$779 billion.

In the first weeks of May, total volumes on HKMEx fell to just 939 lots (see the first chart). With the exchange earning fees of 50 to 75 US cents per lot, there was no way it could remain in business. Trading ceased on Friday.

Exchange chairman Barry Cheung is keeping a brave face on things, saying he plans to raise fresh capital and return with yuan-denominated futures on industrial metals.

Given the exchange's failure first to break into energy futures, then into precious metals, it's hard to share his optimism.

With mainland speculators already trading in Shanghai, and international users preferring the liquidity on the HKEx-owned London Metal Exchange, HKMEx simply has no competitive advantage.

Inevitably, if the stock market is in positive territory at this time of year, someone always trots out the old Wall Street adage "sell in May and go away".

The idea is that trading is thinner during the summer months, so the market is more volatile. And for the most part a rise in volatility means a fall in prices, because markets tend to grind higher, but drop all of a sudden.

As a result, stock market folk wisdom teaches that a wise investor sells his holdings in May, sits on the sidelines over the summer, and buys back into the market in November.

Looking at Hong Kong's stock market, there are some years when this strategy would have worked a treat. Take 2008 as an example. Any investor fortunate enough to sell his portfolio of Hang Seng Index stocks at the end of May would have sidestepped the market's gut-wrenching plunge following the implosion of US investment bank Lehman Brothers in September.

And if he had then bought at the end of October, he would have got back in at the very bottom of the market.

He would still have made a loss of 9 per cent for the year as a whole. But a buy-and-hold investor would have been down 48 per cent - a 39 percentage point outperformance for the sell in May strategy.

Similarly, in 1997 our sell-in-May investor would have avoided the market's July crash and ended the year up 11 per cent. Buy-and-hold investors lost 20 per cent.

On the other hand, anyone selling in May 2007 and buying back at the end of October would have missed the 50 per cent through-train rally, getting back into the market at the Hang Seng's record high just in time to capture the subsequent bear market for a 48 percentage point under-performance.

All in all, if we look back over the Hang Seng's history since 1965, we find that the sell-in-May strategy outperformed in just 18 years, while buy-and-hold investors would have earned better returns in 30 years.

Of course that sample includes the great bull markets of the 1970s and 1980s. But narrowing the sample to more recent times doesn't improve the picture. Over the past 20 years, sell in May outperformed only five times. Over 10 years, only twice (see the second chart).

So next time someone advises you to take your profits in May and sit the summer out, reflect that in Hong Kong at least, the strategy has been far more likely to underperform than to generate the superior returns it promises.