The Key Reason ASX Gold Stocks Are Weak

The Australian gold sector is a world-leading region known for its top tier deposits, politically safe environment, a highly educated workforce, and almost no impact from Covid-19. With all these advantages – why have Australian gold stocks underperformed compared to the rest of the world during the recent gold bull run?

The chart in Figure 1 shows the price movements of Australian gold stocks (XGD – blue) vs global gold mining stocks (GDX – green) for the past 2 years. Here we see Australian gold stocks were actually first to move in early 2019, and outperformed global gold stocks by 10% - 20% for the first three quarters of 2019.

However the fourth quarter of 2019 proved to be an inflection point, with the chart showing Australian gold stocks consistently underperforming their global counterparts by 10% - 40% since this point – a trend continuing through to today.

Figure 1 – Performance of Australian gold stocks (blue) vs global gold stocks (green)

Naturally, the following questions arise – why was the Australian gold sector so severely overlooked in 2020? What changed in the fourth quarter of 2019? Have Australian gold companies become less valuable than companies from other parts of the world?

In searching for answers, the first metric to check is how the price of gold tracked throughout this period. The chart in Figure 2 has added an overlay for the price of gold in both USD (orange) and AUD (yellow). Here we can see the AUD gold price only marginally outperformed the USD price in the first three quarters of 2019, which was during the period of Australian gold stocks dominance.

Figure 2 – Overlay of price of gold in AUD (yellow) vs price of gold in USD (Orange)

The chart also shows the AUD gold price significantly out-performed the USD price during the fourth quarter of 2019 and into 2020, which is completely converse to the Australian gold stock performance during this period.

So the relative gold price metric does not show a strong enough correlation to explain the discrepancy in gold stock performance.

Instead we turn our focus to the fourth quarter of 2019 and investigate what occurred during this timeframe which might have contributed to an inflection point. This period was just before COVID-19 became a global pandemic, and the financial news was saturated by the US Federal Reserve’s handling of the repo market liquidity crisis.

Figure 3 shows that the US Federal Reserve responded to the repo crisis by initiating a fresh round of quantitative easing, expanding their balance sheet by $0.5 trillion. This was considered a significant amount in the 4th quarter of 2019, however it was vastly dwarfed by the $3 trillion expansion undertaken shortly after in response to the March 2020 pandemic crash.

Figure 3 – US Federal Reserve balance sheet

By contrast we can see in Figure 4 the Reserve Bank of Australia did not expand its balance sheet until the March pandemic crash, and the increase was a far smaller amount of only $0.1 trillion AUD.

Figure 4 – Reserve Bank of Australia balance sheet

So the matching timeframes suggest this is a major factor, with the extreme expansion of USD money supply clearly impacting stock markets and causing price elevations of global gold stocks (particularly US gold stocks) well beyond Australian gold stocks.

This leads to the follow-up question – how accurately is the intrinsic value of the global gold sector represented by stock markets? And specific to this article’s topic – are US gold stocks overvalued or are Australian gold stocks undervalued?

Our view at Daybreak is that both Australian and international gold stocks are significantly undervalued and both will see much higher prices over the next few years. However this article has demonstrated that intrinsic value is largely irrelevant in the current economic environment – with stock markets instead operating as a function of central bank’s proclivity to print money.

We continue to believe the underperformance of Australian gold stocks provides an excellent opportunity to gain exposure to the gold sector, and that it will correct strongly once markets return to an intrinsic value based pricing model.

Disclosure: Daybreak Strategies owns a range of Australian and international gold stocks and options.