Ask the Analyst: Why are ASX gold miners overvalued despite a near record gold price?
All that glitters is not gold.
Welcome to ask the analyst, where members of Morningstar Australia’s equity research team answer questions from the Morningstar community. If you have a question about an ASX company or industry in our coverage, please send it to tyger.fitzpatrick@morningstar.com.
Today’s question focuses on why Morningstar’s coverage of ASX gold miners suggests the sector is overvalued, despite a strong and somewhat sustained run in the gold price. While a rising gold price typically supports gold miners’ earnings, our global mining analyst Jon Mills points towards a growing disconnect between gold prices and the long term assumptions used to value gold miners.
To tackle this disconnect, I asked Jon to help highlight how Morningstar approaches gold price forecasting, how those assumptions feed into miner valuations and why some gold miners appear more overvalued than others. Firstly, let’s assess the reasons why the gold price has performed so well over the past two years.
Why has the gold price performed so strongly?
The gold price has risen from USD 1950 in April 2022 to approximately USD 4600 today. Over this four-year period, gold has delivered a compound annual growth rate of 23.9%. By comparison, the ASX200 accumulation index (which includes dividend returns) has generated a compound annual return of 8% over the same period. This is unusual given historically equities tend to outperform gold on average as investors demand higher returns for riskier assets like shares.
Gold’s strong performance has been driven by a combination of macroeconomic and geopolitical factors. Sticky inflation, heightened geopolitical risk and concerns around economic growth have all contributed to an increase in demand for gold. Gold is a perceived store of value allowing investors to hedge against inflation. The gold price traditionally has a low correlation to the share market, which is attractive during a share market downturn.
Central bank behaviour also plays an important role. Ongoing purchases by central banks, particularly in emerging markets have provided structural support to the demand for gold. Investor flows into gold ETFs have added additional demand during the recent gold price surge. Jon describes the ETF demand for gold as procyclical meaning investors will typically buy gold ETF’s when the gold price is already rising and selling when it is falling. This marginal buying and selling amplifies short term price volatility which is why we have seen wild swings in the gold price this year. In the past eight consecutive quarters, there has been record net inflows into gold ETF’s – largely driven by Asian and North American markets.
Collectively, these factors have pushed gold prices to near-record levels for a sustained period. While these forces help explain gold’s recent strength, they do not necessarily determine its long-term value. To assess whether current gold prices and by extension gold miner valuations are sustainable, it is important to understand how Jon approaches the valuation.
Why is our forecast gold price disconnected from the spot?
The midcycle gold price is designed to value a gold miner using a realistic long-term assumption, rather than today’s gold price alone. The midcycle gold price is applied after year four in Jon’s valuation while the gold futures curve is used in those first four years of forecasted cashflow.
The midcycle gold price reflects the long run cost of getting gold out of the ground and is the price needed to sustain global supply through the cycle. In economics 101, we learn that when prices rise (ie. gold), higher cost suppliers (gold miners) are encouraged back into the market which increases overall supply. Overtime, the additional supply gradually pushes prices back down toward the long-term marginal cost. This is where supply and demand typically balance out in a normal market.
Because commodity prices are inherently volatile, relying on the current spot price in long term forecasts risks materially over or understating a miner’s long-term value. This is particularly important when factors such as increased ETF flows and economic conditions are spiking gold prices.
At the start of this year, Jon updated his mid‑cycle gold price assumption to around USD2,050 per ounce. The midcycle price is up around 20% from USD 1,700 when he first reinitiated coverage on the largest gold miners in April 2023. While the midcycle price has increased by around 20% over the past three years, the actual gold price has risen by more than 120%. This highlights a growing gap between gold’s long‑run marginal cost of production and today’s market price.
In the short term, higher gold prices significantly boost miners’ revenues. However, gold prices are cyclical and if prices retreat from current levels, profit margins will shrink. This is particularly true for less efficient producers with higher costs. This is why Jon focuses on where each company sits on the cost curve with the most cost-efficient miners best positioned to weather the cycle.
Screening ASX gold miners
With an understanding of the assumptions underpinning Jon’s valuations for gold miners, we can now examine how these translate on the ASX listed miners. The average price to fair value across ASX listed gold miners is 1.78x. This implies that on average, ASX gold miners in our coverage are trading at a 78% premium to fair value. Even in the past 12 months, the average price to fair value has increased by 12.5%. This suggests investors are continuing to back gold miners despite long term valuation concerns.
The largest disconnect in terms of P/FV is Evolution Mining (ASX:EVN) which has seen its share price triple in value over the past two years. Evolution has benefited from both rising gold prices and its copper exposure which is expected to make up roughly 25% of revenue through the cycle. Jon expects Evolution to increase its gold production by 100,000 ounces by 2030 mainly driven by the Mungari and Red Lake mines. However, Jon thinks this will be more than offset by the significantly lower midcycle gold price starting in 2030.
On the other hand, the cheapest relative gold miner on the list is Northern Star Resources (ASX:NST). The shares are trading close to the same level it was two years ago after falling 20% on downgraded production guidance in March.
Northern Star owns gold mines in Kalgoorlie WA and Alaska. Jon expects 60% of total gold production to come from its Kalgoorlie operations by 2030. Northern Star also recently purchased De Grey mining, owner of the attractive Hemi Gold project in Western Australia. Jon sees the Hemi development adding a further 500,000 ounces of production by 2030. This would make Northern Star one of the largest gold miners in the world by production alone. However, the shares remain materially overvalued given Jon’s midcycle gold price is less than half of the current spot rate.
All four ASX listed gold miners lack a moat. Jon notes that gold mining companies only build a lasting advantage if they own long-life, high quality mines that can produce gold cheaply and efficiently for many years. As a commodity producer, gold mining companies are price takers meaning they are at the mercy of the gold price. While the high gold price stands to benefit producers currently, investors should be aware of the cyclical nature of the gold price and the mechanisms behind it.
