ASX gold shares have plenty of return potential if we can choose the right opportunities. Certainly, there are a number of things to keep in mind when it comes to all ASX mining shares, and there are a few factors specific to gold.
Mining businesses are trying to make a profit just like any other business. It's a process to identify potential mineral deposits, confirm the resource is there, develop the project, and then start production.
The added complexity in assessing mining businesses is that commodity prices can dramatically change over a year, or even just a couple of months.
Portfolio manager Imaru Casanova from VanEck has outlined some specifics when considering ASX gold shares.
The VanEck Gold Miners ETF (ASX: GDX) is invested in ASX gold shares like Newcrest Mining Ltd (ASX: NCM) and Northern Star Resources Ltd (ASX: NST).
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Don't obsess on quarterly earnings
Casanova wrote that companies need to meet their guided targets to gain market confidence, but also acknowledged that there are "unique challenges" in the mining industry.
The fund manager is looking for value creation, so she's not obsessed with quarterly earnings updates and more focused on the long term of the next 10 or 20 years.
She pointed out that these companies are:
…issuing forecasts based on only estimates of the properties of the gold deposits they are mining. We expect that these estimates are a good representation of the gold deposit over the life of the mine. Quarter-over-quarter, it is also reasonable to expect variations from those estimates that could impact earnings, while having no material impact in the net asset value of the mine or the company.
Changes in the gold price can have an impact, but predicting the timing of sales is also challenging.
Free cash flow
For VanEck, free cash flow is the "better way" to assess the "value and investment appeal" of a gold mining business.
The fund manager likes to look at a metric it has created called the free cash flow per ounce. VanEck likes to use this measure to assess the relative valuations of the companies in the ASX gold share universe.
Operational targets
As such, VanEck isn't focused on short-term earnings. It doesn't rush to buy or sell a stock because it beat or missed quarterly earnings until it has assessed the impact of the result on the company's free cash flow forecast over the long term.
Casanova thinks it's important to see how a business performs operationally (such as its production) compared to its expectations/guidance.
The fund manager finished with the following comments about ASX gold shares:
We believe gold equity investors should demand that companies deliver against their operational targets, while focusing less on quarterly earnings and more on the outlook for free cash flow over the next decade or two.
