Adam Thompson: A warm welcome to everyone who has tuned in to this virtual fireside chat. I’m delighted to be speaking with David Garofalo, CEO of Gold Royalty Corp and CEO of Marshall Precious Metals Fund and chairman of the board of Great Panther Mining. David, thanks very much for taking time to have this discussion with me.
David Garofalo: Thanks Adam. Thanks for having me.
Adam: If we could start by discussing your take on the gold mining sector at the moment, and in general, the investment thesis behind exposure to gold and gold mining.
David: Well, I think we’re still fairly early in the game simply because I don’t see an end to quantitative easing any time soon. I don’t see the prospect for significantly higher interest rates anytime soon. Real rates are in negative territory. Governments across the world have strapped on so much sovereign debt to support themselves fiscally during this pandemic crisis, even before they have no reasonable prospect of repaying that debt in a fiscally responsible way, so they’re going to have to print money and debase the currency and debase the debt in order to make that debt more sustainable and supportable in the current environment. So I think that speaks very well for the prospects for gold. And we’re still not anywhere near what the all-time high is for gold on a real basis.
If you go back to 1981, when we last had significant inflation, we saw gold go to US$850 an ounce. In 2021, that would be close to US$3,000 an ounce so while we achieved nominal highs in the last year or so over $2,000 an ounce, we’re not anywhere near this ball-type cyclical hyper gold.
And if you buy into that thesis – and buy into gold as an asset class that you want to invest in – the choices are much broader than they ever were because of the advent of the ETF 15 or so years ago. There is a way to play physical gold, both for retail investors and for institutional shareholders who couldn’t own physical commodities before. So that’s great for the commodity and great for the industry. And then of course you can play gold equities to get that leverage proposition, both in terms of profitability and exploration. Then finally, the royalty companies provide that as well, but also insulate you from underlying costs and inflation risks, which I think is going to rear its ugly head in the industry in a very significant way in the coming months and years.
Adam: How profound then is the need for the growth of resource replacement amongst the producers, if we switched to looking at gold mining now? On the one hand, we’ve seen majors making great money, the fundamentals are probably the best they’ve been for quite a while. They are paying dividends and generalists don’t seem to have jumped in yet en mass. I want to get your take as an investor and a corporate leader. The macro is obviously very strong as you’ve outlined, but why have the mining equities not seen the significant inflows from generalists that we’ve seen in previous cycles?
David: Well, I think part of it is because the general equity markets have been quite robust and gold equities have been seen as insurance against a volatile equity market, but when the equity markets are going in one direction by and large, there isn’t the perceived need for that insurance. The other factor of course, and you’ve touched on it, is the replacement of reserves has been lacking. In fact, we’ve seen reserves decline from their peak about seven years ago, by 40%, and that’s largely through depletion.
So we haven’t as an industry replaced what we’ve been pulling out of the ground. And it’s because we’ve been paying dividends, returning capital to shareholders and deleveraging. We had a fairly significant investment in new mine development, both on the base and precious metal side about a decade ago, as we came out of the credit crisis that led to massive cost inflation, massive debt on the balance sheets of mining companies across the world. To the point where the equity investors just steered clear and the equities vastly underperformed the underlying commodities, because that leveraged proposition wasn’t there due to the massive cost inflation we saw, both in operating capital costs.
And so the industry focused on harvesting what it had built and, by doing that very effectively, costs stabilized to the point where in the mining industry right now we have net zero debt. That’s unprecedented, the balance sheets are squeaky clean. Nobody’s up there raising equity. In fact, they’re buying back stock, they’re doing all the things that you would expect a sustainable business to do, but the one element of sustainability that we’re lacking as an industry is replacing reserves. What we sacrificed during that period of harvesting was reinvesting back in exploration and mine development. And that’s why we find such an acute need for reserve replacement right now. Average mine life globally in the gold industry has gone from 20 years to 10 years for the last seven years.
Adam: I wanted to touch on ESG. You said something in the Northern Miner earlier on in this year which was quite profound around what the industry has to focus on chiefly is water consumption. Quite often we hear the decarbonization piece and that is usually the top line response, whether it’s greenwashing or it is a genuine response from a corporate or a fund, et cetera. Can you reiterate your views around some of the top points on ESG?
David: Well, let me just touch on decarbonization first. I think the industry is embracing that very seriously and they’re measuring it so they’re managing it much better than they ever were and, when I was running Goldcorp, we built the first all-electric underground mine in the world, in Borden. It’s inevitable if technology will get scaled to a sufficient level, and I’m talking about mobile equipment, to the point where it can be used in large-scale mines. So if the technology’s there, it’s just a matter of time to get that skill to a sufficient level and help significantly reduce the carbon footprint. So I’m very optimistic in that regard, but far less optimistic on our water management in the mining industry. And we consume a lot of water far too much of it.
Water, in my view, is the biggest impediment to new mine development because generally we’re going into environments that are water scarce and in remote areas of the world. We’re often competing with existing users of water so that creates a lot of social upheaval. When I look at the value creation chain of the mine sight area, where we use the most water is in tailings management. We must get out of the business of traditional tailings impoundment, and the industry has been far too slow to embrace that. But if we’re able to go to technology, for example, dry stack tailings, which is an accepted technology and it is being scaled as well, if it’s more broadly embraced, we’re going to see a dramatic reduction in freshwater consumption and a dramatic increase in our recycling rates.
Adam: I just had one more question around your take on the crypto impact on the generalist investor, or indeed how that might infringe on an investor mindset. Which approach is needed for mining or mining equities versus crypto, which can be very quick and rewarding, or very volatile?
David: Well that volatility will ultimately undermine its ability to be seen as a reserve currency. And frankly, cryptocurrencies are here to stay. I’m not disparaging them from that standpoint. There will be digital currencies for the foreseeable future and the argument I’ve made against digital currency – at least the valuations they’re at right now, not against digital currency as an asset class, or the need for it – is the fact that there’s no impediment to new entrants in the digital currency space. And in fact, now we’re hearing governments talking about digitizing their own reserve currencies. In other words, they’re going to take ownership of the digital currency market and just make it another fiat currency like their paper currency.
And when there are no barriers to entry, there’s no scarcity value. Whereas gold is very finite in quantity and as an industry, we have a remarkable inelasticity of supply to price. In fact, as price has been going up supply has been going down because of the significant capital impediments to building new mines of technical complexity. And so we won’t see that kind of supply side response to higher gold prices that you might expect, particularly for new entrants, who don’t understand the industry and understand the barriers to entry.
And so I think gold will increasingly be perceived as scarce and cryptocurrencies will be increasingly perceived as not scarce or the opposite of scarcity. I think young investors understand intuitively and instinctively that their digital or their feed currencies are being undermined by central banks. And they’re looking for ways to save their capital and so they’re buying digital currency with that expectation. They will safeguard their capital, but with that kind of volatility and with the lack of barriers to entry, I’d say that’s the opposite of providing protection for your capital.