Demand for palladium is intensifying, according to a white paper from Stillwater Mining Company (NYSE:SWC,TSX:SWC.U) The document is bullish on the metal’s fundamentals and even warns of a deficit. But is the case compelling enough to revive investors’ interest?
Like its precious metal peers gold and platinum, palladium prices began to strengthen in mid-August. On August 17, palladium closed the week with an $11 rise to $588. The following Monday, August 20, the price went to $607. By September 14, one day after the Federal Reserve announced its aggressive QE3 program, palladium was at $695 and had reached a six-month high. These gains were driven by labor turmoil in South Africa’s mining sector and then by action from the the US Federal Reserve.
Since its ascent, palladium has remained well above $600, but momentum has since fizzled and prices have softened.
Investor interest wanes
Interest in palladium seems to have vanished, states a Standard Bank report for the week ended October 5 . The firm points to the net speculative length of NYMEX palladium, calling the 4,500 ounce increase “paltry” and “meagre.”
According to ETF Securities’ 3Q 2012 Global Commodity ETP Trends data, palladium was the only precious metal to have negative net flows from ETFs during the quarter.
North American investors were selling the metal in July while Europeans invested $3 million. In August, North Americans invested $19 million, while investors in Europe became the sellers, dropping $4 million in palladium holdings. In the bullish-for-precious-metals month of September, both regions went on a selling spree, dropping a total of $43 million in palladium holdings, resulting in quarterly outflows of $31 million.
ETFs continue to sell off palladium holdings, said Standard Bank on October 5. With total losses of about 59,000 ounces over the past four weeks, the pre-QE3 announcement buildup in holdings has been completely wiped out, said the Bank.
“The outflows are mainly based on concern over China’s auto growth,” Martin Arnold, a researcher at ETF Securities explained. “It has only been in the last six months that we have really started to see a moderation in China. That is becoming more of a focus now versus the Eurozone story in the platinum market, which has already been priced in.”
Catalytic converters confirm positive outlook
Stillwater’s paper argues that the automotive industry continues to be bullish for palladium because of the metal’s growing use in catalytic converters.
“Looking specifically at growth in emerging markets, China’s automotive production in 2012 is at 18.5 million vehicles and will expand at a CAGR (cumulative annual growth rate) of 5% over the next decade to 30 million vehicles,” the paper states.
The second largest auto market, the US, also continues to produce impressive results. In August, car sales rose to 14.5 million vehicles on an annualized basis, the highest for the month of August in four years, according to a report from A-1 Specialized Services and Supplies. In September, US vehicle sales rose another 9.5 percent, the highest since the cash for clunkers boom in 2009, according to Johnson Matthey.
Analysts project sales of 78 million to 82 million vehicles in 2012. The two largest auto markets, China and the US, are gasoline dominant. Catalytic converters for these vehicles would have once relied upon platinum, but due to price-driven substitution, they now rely almost wholly upon palladium, Stillwater’s paper notes.
The price advantage of palladium substitution has also driven advances in the use of palladium for diesel emissions systems, meaning the metal is also used for the fabrication of Europe-destined vehicles.
“In the laboratory, research has demonstrated the ability to accommodate up to 50% total palladium loading in light diesel applications, although the actual palladium loading in diesel catalytic converters being used today is around 30%,” said Stillwater.
Furthermore, Europe will be moving toward stricter Euro 6 emissions standards in 2014 and China toward Euro 5 in 2015. These events are expected to require additional metal loadings for compliance, which should boost palladium demand.
Given the outlook for the metal’s demand, it seems that investors would be carefully considering supply.
Lost production in South Africa this year due to labor unrest, safety-related closures and the shuttering of mines for economic reasons may result in a loss of 200,000 to 250,000 ounces of palladium A-1 states.
However, palladium has been far less responsive to such supply threats than platinum.
South African supply disruptions are not factoring into the palladium market to the extent that they are in the platinum market because of diversity of the supply base, explained Arnold.
South Africa supplies about 34 percent of the world’s palladium and approximately 50 percent comes from Russia.
However, Stillwater has added its voice to those that warn that the market may be at risk of supply disruptions from Russia. One of the US’s sources of palladium is state stockpiles. There has been ongoing speculation as to when that supply will run out as sales have declined over the past several years.
A-1 notes that imports of Russian palladium into Switzerland, a trading hub, have been significantly lower in recent months when compared to the same time last year, suggesting the Gokhran (the government agency controlling the stockpiles) stocks may be near depletion.
Further declines or cessation of flow from that inventory is considered a significant supply risk.
In 2011, 67 percent of palladium was used for catalytic converters. According to Stillwater, without the the supply from the Russian state inventory, approximately 73 percent of primary palladium production went to catalytic converters.
“Failing to recognize the effect of the Russian inventory sales in the palladium supply is misleading, particularly in view of the current depleted state of this formerly vast Russian stockpile,” states the Stillwater white paper. “Palladium is facing a substantial supply deficit going forward that will likely be met by a combination of price-driven demand destruction and shifting back to platinum or using rhodium.”
Securities Disclosure: I, Michelle Smith, hold no direct investment interest in any company mentioned in this article.