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Top broker picks the last value buy in the ASX gold sector

ASX gold stocks are tipped to outperform today as the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is poised to tumble on poor offshore leads.

The futures market is forecasting a whopping 1.8% drop for our stock benchmark as US and European equities slumped in overnight trade on growing concerns of a painful economic slowdown.

Recessionary fears are always a positive for gold as the spot price for the safe haven inched up to around US$1,500 an ounce.

Are gold shares rallying ahead of fundamentals?

But some experts worry that the ASX gold sector is turning into a value trap! Morgan Stanley is one sounding the warning bell as it believes valuations for local gold stocks are stretched beyond sentiment as these shares are trading on multiples that are at or above previous gold bull runs.

“In the last year average ASX200 forward 12m EV/EBITDA has risen ~26% to 6.6x (up 31% to 8.0x for our coverage),” said the broker.

“Even if we assume our coverage returns to respective peak multiples of 8-11x, we find <20% upside for all gold miners.”

These overpriced miners include some of the most prominent names on our bourse, such as the Newcrest Mining Limited (ASX: NCM) share price, the Evolution Mining Ltd (ASX: EVN) share price and the Northern Star Resources Ltd (ASX: NST) share price.

The last value buy

But there’s one exception. The broker thinks the only gold stock under its coverage with material upside is the Regis Resources Limited (ASX: RRL) share price.

“Spot EV/EBITDA multiples are typically quick to price in gold appreciation but NCM, EVN and NST are all trading above their 3yr averages,” explained Morgan Stanley.

“From a relative perspective, RRL is the only one showing some valuation support as it trades close to its -1 std deviation.”

Morgan Stanley has an “equal-weight” recommendation on Regis Resources and an “underperform” rating on Newcrest, Evolution Mining and Northern Star.

Foolish takeaway

Few (including me) would argue that value is as hard to find as a gold nugget in the Pilbara, but overstretched assets can trade a premium for extended periods, and the same may be true for gold shares.

What’s happening in the bond market is reinforcing my view. Not that long ago, many experts where warning of a bond bubble as yields collapsed before central bankers turned aggressively dovish.

Few are talking about a bond market bubble now, and some think it’s still worth buying government debt even as yields head towards zero or have turned negative.

The same factors driving bond prices to sky-high valuations are also turbo-charging the gold sector. If no one is too worried about bond prices, I think it’s premature to fret about gold.

Having said that, this doesn’t mean that better valued gold stocks shouldn’t be higher on your watchlist.

Where to invest $1,000 right now

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for more than eight years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes are the five best ASX stocks for investors to buy right now. These stocks are trading at dirt-cheap prices and Scott thinks they are great buys right now.

*Returns as of June 30th

Motley Fool contributor Brendon Lau owns shares of Evolution Mining Ltd. Connect with him on Twitter @brenlau.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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