We have been writing quite frequently about the virtues of platinum
ownership in recent months, and while we believe this industrious precious
metal offers robust potential upside over the coming months and years, we are
cautious not to overlook its counterpart that is palladium.
Like platinum, palladium is integral in the catalytic
converter market. When used with platinum and rhodium the three metals capture
harmful hydrocarbons, carbon monoxide and nitrogen oxide. One of the key differences
between platinum and palladium is their usage concentration within the auto
catalyst market. We have written in the past that platinum has a broader range
of usage with 37% of its annual production going into auto catalyst production.
By comparison, the catalytic converter sector accounts for 72% of palladium
production.
Strong Auto Sales are
Key
Given the slump in commodities, palladium has held up rather
well and we continue to see upside potential this year. Given its direct
ties to auto sales, we are confident in the upward trajectory of palladium.
Recent reports
indicate 2015 will be a strong year for auto sales in the world’s top two
markets, North America and Asia.
North America represents approximately 27% of the world’s
auto sales and industry experts are calling for a 2.5% increase in sales this
year over last year in the U.S. to 20 million units. Asia accounts for approximately
45% of worldwide auto sales with a majority of those sales stemming from China.
Chinese auto sales are expected to grow 7% year-over-year to 25.2 million units
in 2015. This bodes well for palladium as this metal is used more frequently in
gasoline burning engines (platinum is more frequently used in diesel). Lower
gas prices, a recovering U.S. economy and an aging U.S. auto fleet also seem to
be setting the stage for a strong year in auto sales.
Supplies are Tight
Similar to platinum, the demand characteristics for this
metal are encouraging but that is only half the story. On the supply side,
there are several nuances that further the case for ownership in this metal.
Palladium demand has outpaced supply for the past several
years and that trend
looks to continue into 2015. “Overall,
Barclays sees the palladium sector as being in a significant shortfall. With
analysts here estimating that the supply deficit during 2014 may have reached
as much as 1.65 million ounces--one of the biggest supply shortages seen today
in any metals market. The bank expects that situation to continue in 2015.
Forecasting a supply deficit of nearly 560,000 ounces this year.”
Part of the problem according to this report
is the primary source of palladium supplies. According to Johnson Matthey, in
2013 palladium global supply from primary sources was 6.4 million ounces. Of
these ounces produced 37% or 2.6 million ounces came from South Africa and 42%
or 2.7 million ounces came from mining and stock sales in Russia. These two
countries are by far the leaders of the palladium producing countries. North
America was responsible for 930,000 ounces of palladium to market and Zimbabwe
produced 310,000 ounces or 14% and 5%, respectively. The remaining 2% is
provided in a fragmented way across the globe.
Russia is a major producer of palladium as a by-product of
their nickel production and it is estimated that Russian stockpiles have been
dramatically reduced in an attempt to make up for slack supply. We use the term
estimated simply because it is unclear what Russia holds in reserves as that
information is tightly guarded my Russian officials.
Ore grades in Russia are deteriorating and Russian palladium
is a by-product of this mining activity, therefore primary production from
Russia is in decline. According to industry experts, palladium mine production
peaked in 2004 and aging mines are producing less material. It is estimated
that production at these mines has deteriorated at an annual rate of 6% from
their peak while operational costs have increased at a rate of 20% per annum.
“Barclays notes that
the availability of palladium globally took a big dive during the past year.
Because of one critical factor: the world's top-producing nation, Russia. Data
show that Russian palladium shipments into major trading hub Switzerland
plummeted in 2014. Falling 64% to 184,000 ounces--down from over 517,000 ounces
in 2013. In other parts of the world, the pattern was similar. With Russian
palladium shipments into China showing a 45% drop on the year, to just under
97,000 ounces. The fall-off is almost certainly due to tightening sanctions
against Russia. Perhaps combined with Russian unwillingness to part with this
strategic resource amid the current uncertain political environment. Whatever
the reason, this is a major shift in the global palladium market.”
Trading Palladium
One place for an investor to look for palladium exposure is the
ETFS Physical Palladium ETF (ticker: PALL). This ETF has roughly $380 million
in net assets and trades just north of $75. The charts below show the resilient
uptrend this metal has exhibited despite the commodity bear cycle that occurred
in late 2014. On both the daily and weekly charts, this ETF is sitting on its
support line.
The supply and demand fundamentals warrant an investment in
this precious metal and it appears the technicals are highlighting an
appropriate opportunity.
Joseph S. Kalinowski, CFA
Twitter: @jskalinowski
