Despite gold’s massive rally over the past year, gold mining stocks remain undervalued, said VanEck.
“Since gold broke out on June 20, 2019 into its current trend, the gold price has gained 45% and the NYSE Gold Miners Index 79%. However, this outperformance has not led to overvalued stocks,” VanEck said in a Seeking Alpha post last week.
Gold rallied to new all-time highs around $2,070 an ounce in August but quickly became overheated, triggering a correction. Gold now sits between $1,900 and $2,000 an ounce with December Comex gold futures last trading at $1,960.70, down 0.15% on the day.
“Gold had become overbought in the past month, trading well above trend, making it ripe for a correction. Once gold started to fall, momentum built as profit-taking set in and bullion exchange-traded products saw their first redemptions since June,” wrote investment management firm VanEck.
With higher gold prices, why are the gold stocks still not overvalued? VanEck pointed to fixed mining costs and any gold price increase being a “pure profit.”
“An analysis of our senior/mid-tier universe shows that on average, an 11% increase in the gold price from $1,800 to $2,000 per ounce brings a potential 29% boost to free cash flow. Resources in the ground also become more valuable at higher prices. This may raise the value of a company, such that gold stocks generally have to outperform gold by over 30% in order for valuations to climb. We have yet to see such outperformance in this market,” VanEck wrote.
When looking for which miners to invest in, pay attention to the base gold price used by the company, said VanEck. Base price represents “the lowest price that gold might go, in order to ensure that projects prosper through the cycle.”
Before this year’s massive price rally in gold, most of the mining companies have been using the $1,200 price for their projects.
This means that there is a lot of opportunity in the mining stocks at the moment, according to VanEck.
“When generalist investors take a look at this sector, they will like what they see. Berkshire Hathaway’s (BRK.A, BRK.B) new stake in Barrick bears this out. Barrick and many other companies we invest in have every intention of maintaining their discipline by controlling costs, controlling debt and using $1,200 per ounce as the benchmark for evaluating capital projects,” VanEck wrote.
Higher gold prices will also trigger new low-quality gold mines being built, such as IAMGOLD’s (IAG) Cote Lake project — a 6.6 million ounce low-grade gold deposit in Ontario, Canada.
“These are deposits that were not economic at lower prices because they would have high operating costs and/or high capital costs due to low grades and/or mining challenges … On July 21, 2020, IAMGOLD announced it will proceed with construction, raising its gold price assumption from $1,250 to $1,350 in order to justify its decision. A handful of other companies have also boosted their project price assumptions to as much as $1,541 per ounce … There are also a growing number of junior companies that are now able raise money to develop low-quality gold deposits,” VanEck said.
The investment firm forecasts gold to rise above $3,000 an ounce in the long-term, which if true, means that the mining companies will be successful.
However, VanEck cautions against embracing base prices that are too high. “It would be reckless to build a mine and risk a company based on such forecasts. It takes up to seven years to construct a mine and achieve payback of investment, if all goes as planned. In the last gold cycle, gold topped at $1,921 and bottomed at $1,050, much lower than most had anticipated. Gold is again in the $2,000 neighborhood. Everyone knows there will be another bear market, but no one can know whether it comes in a year or a decade,” VanEck wrote.
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