Are Palladium Investors Employing the Best Strategy?

Supply and demand fundamentals have long painted a bullish picture for palladium. The metal is very rare and mostly produced as a by-product of nickel and platinum. Despite this limited production, lawmakers are inking legislation that essentially requires increasing demand. Given the situation, supply deficits appear inevitable. But the million dollar questions are when it will happen and whether investors will be on board or on the sidelines suffering from fatigue.

Investors taking positions in palladium on the basis of supply concerns are often looking for tightness or disruptions in the near term. To the disappointment of many, past predictions of shortages have failed to come to fruition, and consequently market softness has set in as investors turn away.

Many analysts are predicting that palladium will put up a stellar performance this year. The median Bloomberg analyst forecast has palladium averaging $850 in Q4 2012, which is a rise of more than 30 percent above current prices.

Citigroup recently issued a research note expressing its bullish position and revising its 2012 price outlook up to $801.

Furthermore, there are again predictions of a deficit this year. Barclays Capital, for example, sees the possibility of a 215,000 ounce shortfall.

Optimism seems to be spreading to investors. Last month, reporting a surge in investment activity, Bloomberg revealed that palladium held in ETPs was 58.9 tons, surpassing the 43.5 tons held in platinum ETPs.

With the release of its Global Commodity ETP Quarterly, ETF Securities noted that a revival of risk appetite drove significant increases of flows into pro-risk, pro-cyclical commodity ETFs, including palladium, which saw net flows of $186 million in Q1.

However, the futures market, which recently saw weeks of retreat by the longs and growth among the shorts, shows that there are still investors prioritizing short-term factors.

If people remain focused on the fundamentals, perhaps such volatile attitudes will change and the currently weak prices will serve as a ticket for more people to get into the market and ride it for the long haul. Such a change could also prevent the fatigue of entering and exiting with the headline chasers.

Palladium usage

Palladium is a metal used to make jewelry and a wide range of other products in the chemical, medical, and electronic sectors. Its largest source of demand, however, is for use in autocatalysts, and is virtually cemented into place by increasingly strict environmental regulations.

Palladium is used to reduce hydrogen emissions. It does so more effectively in gasoline engines than in diesel engines. Since it is much cheaper than platinum, which can also be used for this purpose, palladium is dominant in gasoline autocatalysts. And given the cost advantage, it is also used in the largest quantities possible to substitute for platinum in diesel engines.

Overview of vehicle market

Palladium’s uses make it highly sensitive to economics, especially any movements involving or impacting vehicle sales. As China and the US, the two largest auto markets, are both gasoline dominant, the market pays special attention to relevant news from these nations.

Concerns that China is slowing down have weighed on palladium. In a 2012 market report, Deutsche Bank noted the possibility of demand and pricing risks in Europe, Brazil, and China. And the Chinese auto market did indeed start the year in a weak state, though sales picked up in March.

The US auto market is off to a good start, as projected by Deutsche Bank, which noted that auto lenders, including those servicing subprime buyers, used securitization to raise $67 billion for the year, with further growth likely.

Johnson Matthey reported that March car sales increased for automakers or markets in South Korea, India, Germany, the US, South Africa, and the UK.

Autocatalyst demand is expected to continue growing as rising incomes in emerging markets allow more personal vehicle purchases. Also, in addition to its normal appetite for vehicles, the US has a significant aged fleet traveling its highways, and analysts expect consumers to go into replacement mode in the near future.

Of the 6.91 million ounces of supply that Barclays forecasts for 2012, automakers are expected to use 6.24 million ounces.

Palladium supply

However, Barclays forecasts that supply from mines and stockpiles will drop 6.9 percent this year.

South Africa, one of the world’s largest producers, is playing its part to make that prediction a reality. The nation’s PGM miners are seeing their production figures hammered by labor strikes and safety stoppages, both of which are expected to be an ongoing problem.

Recently, quarterly production declines have also been reported at mines in Canada and the US.

The Russian government has kept the market out of deficit territory in the past by selling palladium from its stockpiles. For years, there has been speculation about how long that will continue. Wiktor Bielski, Global Head of Commodities Research for VTB Capital, offered some certainty.

“Gokhran which is the official government stockpiling agency in Russia announced last year that this year will be the last year of official stockpiles sales although there may be some old reprocessed materials that they may sell next year. But there, we’re talking very, very small quantities,” he said.

Many believe sales from the stockpiles will end when they are depleted, but that is a matter of sheer speculation.

“They [Gokhran] didn’t however say that they would be stopping stockpile sales because they’ve run out. They just said they will be stopping,” Bielski added.

He said that it is likely that Russia will keep some palladium that it deems strategic, but how much is difficult to estimate.

VTB Capital also believes that a deficit will occur this year, perhaps as much as half a million ounces.

However, investors looking for rewards in the short term may still be disappointed.

Bielski said that there are independent stockpiles of platinum and palladium in existence, though no one knows how large those are. And, in the early years, deficits could probably be met from that supply, assuming the holders of that metal are prepared to use it for those reasons. But, he warns that those stockpiles won’t last long.

“There is going to come a time when there is going to be a very serious imbalance [in the palladium market] because we’ve relied for 20 years on those [Russian] stockpile sales meeting the gap [between supply and demand] and those stockpile sales won’t be there anymore,” Bielski said.

“Palladium will be a very interesting market in the next 3 or 4 years,” he added.

Securities Disclosure: I, Michelle Smith, do not hold equity interests in any company mentioned in this article.