Is it a mistake to kill gold stocks that deviate from the price of gold?

Recently, gold has continuously hit new highs, rising to 2630 yuan. The GDX Gold Mining ETF in the US stock market has also reached a new high. However, among the top ten holdings of the GDX ETF, only the stock price of Zijin Mining is significantly deviating from the price of gold. The US gold stocks in GDX have either reached recent highs or set new records, with the worst scenario not being gold prices rising while stock prices are falling.

This situation also reflects the A/H market's gold stocks. While the price of gold is at a new high, A/H gold stocks have recently experienced the largest decline of the year. Under unfavorable market sentiment, it seems that the narrative about gold that the market was discussing two months ago is no longer valid.

I. Gold price keeps hitting new highs, copper story ends

When the price of gold continues to hit new highs and A/H gold stocks, as well as gold jewelry stocks, are experiencing significant declines, it does raise some doubts. Especially considering that in the past two months, when the market was very optimistic about gold stocks, the sudden disconnection between gold stocks and the price of gold is puzzling.

There are two recent reasons that have affected the correlation between gold stocks and the price of gold.

Firstly, while the price of gold has been rising recently, the price of copper has been falling. The revenue ratio of gold and copper for most domestic gold stocks is 5:5, with some better-performing gold stocks having 60% of their revenue from gold, while others have 60% of their revenue from copper. Therefore, when the price of copper falls significantly, it offsets the rise in the price of gold. Gold stocks with higher copper revenue are more affected.

It is worth mentioning that in the first half of the year, the market was more concerned about the trend of gold prices when buying gold stocks, and the trend of copper prices was secondary. The continuous narrative of historical highs in gold prices was more attractive, and people did not pay much attention to the potential impact of copper prices. Of course, copper prices also rose by 40% in the first half of the year, which was not inferior to gold in terms of periodic gains, and contributed significantly to corporate profits.

However, copper prices started to accelerate their decline in June, dropping by more than 20% at one point. This decline in copper prices actually brought negative feedback to gold stocks. It can be compared to gold and copper being dual drivers, but when copper prices started to plummet significantly, the market did not anticipate this, and this became the biggest variable leading to the decline in gold stocks.

Looking back at the views of various institutions on gold and copper prices in the first half of the year, the optimism towards gold changed from initial skepticism to consensus. This was because the correlation between gold and US interest rates weakened, the US dollar was approaching rate cuts, and the allocation demand from central banks supported gold. The logic for gold continued to be positive.

On the other hand, the situation for copper was not the same. In fact, the fundamentals of copper were somewhat negative because global demand for copper was not as high. The main reason for the rise in copper prices in the first half of the year was that several major copper miners in South America stopped production this year. Goldman Sachs predicted that copper supply would grow by 2% this year, less than the market's expected growth of 6%, making this year the weakest level since 2020. **Furthermore, the market expected the US and China to continue cutting interest rates this year to stimulate copper prices. Therefore, the market had high expectations for copper, with more speculation compared to gold. At that time, Goldman Sachs set a target price of $15,000 per ton for copper by 2025 In other words, although the demand for copper is not strong, the suspension of copper mines by copper miners has not led to a significant increase in supply. The key point for the market to speculate on the price of copper is to see when the US dollar will cut interest rates to stimulate the economy and cause inflation again, provided that there is no risk of recession in the US economy.

However, in June, both domestic and US economic data weakened, and demand began to weaken. Normally, Chinese copper inventories tend to decrease in the second quarter, but this year they did not. On the contrary, inventories have increased significantly. Currently, copper inventories in the Asian region of the London Metal Exchange have soared to the highest level since 2016, with the decrease in inventories much less than expected by Goldman Sachs.

The weakening of domestic and foreign economic data combined with the risk of recession in the US has disrupted the market's speculation on the price of copper. Starting from June, the price of copper has been falling all the way, and Goldman Sachs has also lowered its target price for copper from an average of $15,000/ton in 2025 to an average of $10,500/ton. This also indicates that the speculative nature of copper prices is strong. The previous increase was more driven by expectations of interest rate cuts, with fundamental factors contributing to the rise being relatively limited. This is also why the market holds two different views on copper prices, with buying copper prices more focused on speculating on the timing of interest rate cuts rather than optimistic about actual demand.

Returning to the trend of gold stocks, looking at Zijin Mining and China Gold International, which are relatively active in gold stocks this year. From May 20 to early August, copper prices fell by 21% from their highs, gold prices rose by 2%, while Zijin Mining and China Gold International fell by around 20%.

So, with stock prices falling so much, gold hitting new highs, and copper prices rebounding, is there a chance for valuation repair in this round?

Second, the timing of the recovery of gold stocks in this round

Looking at the low point of copper prices in early August, from early August to now, gold has risen by 10%, copper prices have rebounded by 10% after hitting bottom, while Zijin has only rebounded by 10%, and China Gold International has not only failed to rebound but also fallen by 17%. Obviously, there is a significant difference in the market here. It is not necessarily wrong to say that this round of gold stocks is oversold, because the sharp decline in copper prices has offset the rise in gold prices, and we cannot just look at the record high gold prices.

It is worth noting that currently, interest rates have been cut domestically and in the US, gold prices continue to hit new highs, copper prices have also bottomed out and rebounded. The next step is to be optimistic about the continued rebound of gold stocks. Firstly, because the decline in this round has been too large, gold has also risen significantly, leading to a certain degree of market sentiment being pessimistic and undervalued. Secondly, because the loose monetary policies in China and the US support the rise in copper prices, which is the biggest catalyst for copper prices. The rebound strength depends on the proportion of gold/copper revenue of each company. Companies with a higher proportion of gold will rebound faster, while those with more copper will rebound slower, waiting for the rebound of copper prices.

For example, Zijin Mining's gold/copper revenue ratio is around 6:4, while China Gold International's copper revenue accounts for 60%, with gold revenue at 40%, resulting in a slower rise in this rebound. This is also why there is a divergence in the trends of domestic gold stocks and U.S. gold stocks mentioned at the beginning of the article, as the gold revenue proportion of U.S. gold stocks is quite high.

We can compare Zijin Mining and NME Newman Mining in the GDX ETF. NME's revenue in the first half of the year was $8.4 billion, with gold revenue accounting for $7 billion and other metal revenue accounting for $1.4 billion, with the majority of revenue coming from gold.

The other gold stocks in the GDX ETF also have a very high proportion of pure gold revenue, with basically over 90% of revenue coming from gold. For example, AngloGold Ashanti's revenue in the first half of the year was $4.5 billion, with only $1-2 billion in by-product revenue, so the trend of AU's stock price is almost identical to the gold price.

Zijin Mining's total revenue in the first half of the year was 150.4 billion yuan, with the copper business revenue accounting for 29%, copper gross profit margin at 49%, while gold revenue accounted for 46.5%, with a gold gross profit margin of 28.3%. On the contrary, copper's contribution to gross profit margin is significant, so when copper falls, the negative feedback on profitability will be greater.

A 6:4 revenue ratio will be more favorable when both gold and copper prices rise together, as the elasticity brought by copper prices will be greater than that of gold. Just like the first half of the year with gold stocks, the dual drive of rising gold and copper prices. Although the high-profit elasticity driven by copper prices has stopped, there is still an opportunity because both China and the U.S. are entering easing measures together, and the market speculation logic will gradually return. At least copper prices have stopped falling.

Regarding gold, the logic of the rise has been discussed too many times before, and everyone is familiar with it, so I won't repeat it. However, I have recently observed a few interesting points that have changed the previous market consensus An overseas gold researcher stated that although it appears that the central bank has paused its gold purchases, the People's Bank of China has not been increasing its gold reserves in recent months. However, it is possible that the central bank is increasing its gold reserves through more covert means, such as importing gold bars in London, refining them in free trade zones, and not directly storing them in the Shanghai Gold Exchange to avoid being recorded in the exchange's withdrawal volume.

Due to the delayed relationship between the central bank's gold accumulation report and gold exports from the UK to China, by comparing data, it can be observed that the central bank started purchasing gold several months before disclosing its holdings information. The market has underestimated the amount of gold purchased by the central bank in 2015, 2019, and 2022. Similarly, another foreign analyst recently revealed that the Saudi central bank has quietly been increasing its gold holdings in Switzerland since 2022, accumulating a total of 160 tons of gold. If this news is true, Saudi Arabia may be the second largest central bank buyer of gold after China.

On another note, regarding the trend of gold jewelry stocks, the market previously believed that as gold prices continued to rise, people would continue to buy gold jewelry as a store of value. At least from the reports disclosed in the first quarter of this year, people continued to buy gold in large quantities, and the market considered the trend of gold jewelry stocks to be related to gold prices.

However, starting in the second quarter of this year, consumers began to reduce their purchases of gold jewelry and turned to buying gold bars. Some consumers believed that the price of gold jewelry was rising too quickly and were concerned about buying at the peak, leading them to adopt a wait-and-see attitude. As gold prices continued to rise without turning back, traditional gold jewelry stocks like Chow Tai Fook and Lao Feng Xiang saw lower-than-expected sales, making them among the worst-performing gold-related stocks recently.

Instead, Lao Pu Gold, which was listed not long ago and focuses on luxury gold jewelry, has seen an increase in sales during this period. The jewelry prices have been raised along with the gold price, and the stock price has doubled since its listing. This seems to indirectly indicate that high-end consumers are more inclined to buy as the price of gold rises.

Conclusion

Is it fair to say that this round of gold stocks was misjudged? It may not be entirely wrong, as there are reasons for the decline, but this round has seen limited rebound due to poor market sentiment.

There is potential for valuation recovery in gold stocks going forward. At least with gold prices hitting new highs and copper prices, which previously impacted profit elasticity, stabilizing and rebounding. However, the only concern is that while gold prices have risen significantly, A/H gold stocks have not seen much increase. If gold experiences a correction in the future, gold stocks may also decline accordingly ​