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Gold Stocks Still Undervalued 2
By: Adam Hamilton | April 21, 2023

The gold miners’ stocks continue powering higher on balance, growing their strong upleg. Yet despite their great gains over this past half-year, gold stocks still remain undervalued relative to their metal. Mean reverting sharply higher out of last year’s anomalous extreme selloff, this battered sector still hasn’t even regained recent years’ average valuations. That implies this mounting upleg still has lots of room to run.

The gold standard for stock valuations has always been traditional trailing-twelve-month price-to-earnings ratios. Any company’s stock price is simply divided by the sum of its last four reported quarters of bottom-line earnings per share. Reported to national securities regulators, these actual recent hard accounting profits minimize estimates. They are way superior to forward P/Es, which are based on guesses of future EPS.

After every quarterly earnings season, I analyze the latest results reported by the 25 largest component companies of the leading GDX gold-stock ETF. Among much other data, we gather TTM P/Es for these major gold miners. But unfortunately those are regularly distorted by large one-time non-cash expenses that are flushed through income statements. This industry’s biggest one is mine-impairment charges.

As companies build and buy mines, their costs are capitalized as assets on balance sheets. But when key assumptions for mine forecasts change adversely, companies are required to write down assets to lower fair values. Mine impairments can result from lower-than-expected ore grades, higher-than-expected mining costs, metallurgy difficulties, geological challenges, geopolitical threats, and even higher interest rates.

While individual major gold miners don’t suffer valuation-skewing non-cash impairment charges often, the GDX-top-25 companies collectively are usually reporting some. That makes traditional valuation analysis on this sector difficult. Just in the latest-reported Q4’22, the world’s two biggest gold miners dominating GDX near 1/5th of its total weighting both had huge mine-impairment charges torpedoing their P/E ratios.

Newmont’s terrible $1,477m Q4 loss resulted from $1,317m of impairments across three mines as well as a $620m reclamation charge. Without these unusual items alone, it would’ve earned a $460m profit! Barrick Gold had its own $950m impairment charge on three of its own mines, which was partially offset by a much-rarer $120m impairment reversal on another. That left it with an ugly $735m accounting loss.

TTM P/E analysis won’t work with losses driven by big non-cash charges. They can be reversed out, but that’s labor-intensive and potentially subjective. Sometimes gold miners don’t publish sufficient detail on unusual income-statement items to make them clear, complicating analysis. Thankfully gold stocks have a great valuation proxy unique to this sector, the ratio of their collective stock prices to prevailing gold levels.

That GDX VanEck Gold Miners ETF is the most widely-followed measure of major-gold-stock prices. It pairs nicely with the mighty American GLD SPDR Gold Shares gold ETF, which is the world’s largest by far. Dividing the former’s price by the latter’s yields the GDX/GLD ratio or GGR. When charted over time, this construct reveals when gold stocks are undervalued or overvalued relative to the metal they mine.

The GGR works because gold-mining profits directly mirror and amplify underlying gold trends, and stock prices ultimately follow profits. A gold miner with $1,225 all-in sustaining costs earns $375 per ounce at $1,600 gold. But if gold rallies 25% to $2,000, those profits more than double soaring 107% to $775 since AISCs don’t change much. These numbers reflect major gold miners’ actual experience over the past six months.

This chart superimposes the GDX/GLD ratio and some of its key technicals over the raw GDX during the last couple years or so. At this gold-stock upleg’s latest high-water mark in mid-April, the GGR climbed to 0.189x. In other words, a share of GDX was worth 18.9% of a share of GLD. Interestingly even that remained below the three-year GGR average of 0.195x from 2020 to 2022! Gold stocks are still undervalued.



How is that possible with GDX just blasting 63.9% higher at best over 6.5 months? Shouldn’t gold stocks collectively be back in overvalued territory relative to their metal? Normally they’d be getting there, but last year this sector plummeted in an exceedingly-anomalous extreme selloff. In just 5.3 months into late September, GDX cratered a gut-wrenching 46.5%! That crushed the GGR way down to an absurd 0.145x.

That left gold stocks the most undervalued they’d been relative to gold since in the dark heart of March 2020’s brutal pandemic-lockdown stock panic! Amazingly even during that, the GGR only closed lower on two trading days. So last autumn’s left-for-dead gold-stock prices were wildly unsustainable. I warned about that one trading day before GDX and the GGR bottomed in an essay on that false gold-stock panic.

That epic valuation disconnect was fueled by the Fed’s most-extreme tightening cycle ever, a blistering series of monster rate hikes off zero accompanied by money-supply-shrinking bond selling. That savage hawkishness catapulted the US dollar stratospheric to extreme multi-decade secular highs, unleashing massive gold-futures selling hammering the yellow metal lower. The gold-stock carnage was collateral damage.

With gold stocks unrighteously both extremely undervalued and extremely oversold from late September to early November, we aggressively bought crazy-low to fill our newsletter trading books. Our unrealized gains since on individual mid-tier and junior gold-stock trades have soared as high as +123.6% this week! Always staying informed on the markets pays out big, enabling smart contrarian trading to buy in really low...

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