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Is the gold price too high for investing in ASX gold shares?

figurine of a bull standing on gold bars
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At the time of writing the gold price is sitting slightly above the US$1,800 barrier for the first time since 2011.

Gold is a hedge against chaos. That is because when things go really bad for an extended duration, then the gold price rises while equities fall. So too, gold mining shares.

For example, since the start of the year the Evolution Mining Ltd (ASX: EVN) share price has risen by 63.47%. Consequently, it is currently trading at a price-to-earnings ratio (P/E) of 38.16. This is astronomical for a mining company.

To illustrate the point, Fortescue Metals Group Limited (ASX: FMG) is performing well as a company, yet is trading at a P/E of 6.61. BHP Group Ltd (ASX: BHP), the world’s largest mining company, has a P/E of 13.87.

So, is the gold price too high to invest in? 

Investing in gold

If you are going to invest in ASX gold shares, then its important to understand a few basic concepts.

First, only about 48% of gold is used in jewellery. Approximately 44% is bought by investors, including central banks, and the rest finds its way into technological equipment.

Second, about 80% of all the gold we know about is above the ground. So in a gold rush, we have more and more people chasing smaller and smaller reserves of gold. Moreover, gold is not only rare on earth, it is one of the rarest metals in the universe – gold and other precious metals are formed at the moment a star goes supernova. 

Third, and importantly for investors, ASX gold mining shares do not pay significant dividends. 

In summary, the gold price is driven by investor demand, so it can fall as quickly as it rises, and the benefit for investors in a gold mining company is share price growth, because there aren’t many dividends to speak of. 

Where are the bargains?

Personally, I don’t think there are many bargains to be found in the established gold miners right now. As stated, Evolution Mining has a P/E of 38.16. Northern Star Resources Ltd (ASX: NST) has a P/E of 48.37. Even Newcrest Mining Limited (ASX: NCM) has a P/E of 31.97.

Will these share prices rise further? Probably. Particularly during earnings season when Northern Star and Saracen Mineral Holdings Limited (ASX: SAR) announce what they have been able to achieve with the recently acquired Kalgoorlie Consolidated Gold Mine, or Superpit. 

But who knows for how long, or how high? Or, for that matter, how far they will fall when the gold price suddenly snaps back (if it ever snaps back).

Enter the explorers

My preference for commodities investing, just like any other form of investing, is to buy a company I can keep for a long time. That means buying a gold explorer at a point where it has a solid reserve and is ready to start moving to the producing phase. 

Personally, I have purchased Bellevue Gold Ltd (ASX: BGL) shares. With its Bellevue gold project in Western Australia, the company is sitting on possibly the highest grade gold deposit in the world today. Not only that, but it is in an area that has been previously mined. As such, the costs for infrastructure are going to be low, and the gold depth is less than many other deposits in Australia.

The company recently raised $100 million via institutional placement, and is raising another $20 million via a share placement with retail shareholders (you and I). This is for project acceleration, so, more exploration, mine development and non-process infrastructure.

Foolish takeaway

At this stage in the gold price cycle, the established gold miners are very expensive, but in my view the gold explorers remain a good investing option. I have shown why I bought Bellevue, but there are a range of others also. For example, the Yamarna Terrane of the eastern Yilgarn by Gold Road Resources (ASX: GOR) and the Red 5 Limited (ASX: RED) King of the Hills gold deposit, as well as a raft of micro caps.

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Returns as of 6th October 2020

Motley Fool contributor Daryl Mather owns shares of Bellevue Gold Ltd and Fortescue Metals Group Limited. 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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Daryl Mather