Is Palladium’s Response to Manufacturing Data Justified?

Economic concerns have been making palladium investors nervous. Last week’s release of Flash PMI data that suggests a global slowdown – including a contraction in China – only aggravated matters. The metal, which started the week with a close of $633, ended at $606. But was the decline justified?

Negative sentiment toward palladium based on broad manufacturing data can be unwarranted and may contribute to faulty investment strategies. The auto sector, which accounted for over 60 percent of total palladium demand in 2011, consumes the majority of annual supply of the metal. When considering manufacturing’s relevance to the market, investors should focus most heavily on this sector.

It is especially important to focus on China and the US. The world’s top two auto markets are gasoline dominant and thus palladium intensive.

Auto sales

Despite concerns about a global economic slowdown, vehicle sales in China and the US have held up, and their 2012 outlook remains positive.

China’s passenger vehicle sales for May were up over 16.6 percent compared to May 2011.

Though total vehicle sales for the first quarter were down 3.4 percent, A-1 Specialized Services & Supplies noted that moderation of sales in China may be linked to the government intentionally slowing growth to avert an overheating in particular industries.

However, with 4.79 million vehicles sold in Q1, China is still on track to meet a projection of 18 to 19 million unit sales, similar to last year.

The US has also seen strong auto sales this year, though there has been some softening in the market recently.

Over 1.3 million cars and trucks were sold in May, a 26 percent increase over sales in May 2011. Though positive, this figure is below what analysts expected, and resulted in an annualized rate of 13.9 million as opposed to the anticipated 14.5 million.

According to J.D. Power and Associates and LMC Automotive, retail sales in the US should be near 1 million units in June, a 16 percent increase over last June. If this outlook holds true, the annualized rate will be about 12 million units.

More than a million additional vehicles were reportedly built in North America through May when compared to 2011 production levels. And, J.D. Power forecasts output will reach 15 million as opposed to the 13 million produced last year.

Other markets that have seen positive performance include the UK, South Africa, Brazil, and Japan.

Confidence in the palladium market, like many others, has been shaken by the Eurozone crisis. Yet while Europe is a diesel-dominant market, it should not be ignored. In recent years, palladium has benefited from technology that allows higher loadings of the metal in diesel autocatalysts. This statement should be put into proper perspective; a decline in Europe’s auto market is not as detrimental to palladium as it is for platinum.

Though some markets’ sales have softened or come in below expectations, overall the outlook for global auto sales remains positive by many accounts.

CPM Group forecasts that auto demand for palladium in 2012 will reach 5.3 million ounces.

Other industries that use palladium, such as electronics, chemical and petroleum refining, and dentistry, are also expected to be sources of growing demand this year.

Palladium supply

Growth in palladium supply is a different story. CPM Group recently said there is a possibility that the palladium market will fall into deficit this year.

Similarly, Norilsk Nickel advised the market to expect a declining supply of palladium from Russia this year.

Supply increases from South Africa are also considered unlikely, or nominal at best. Production losses due to government-led safety stoppages and labor disputes weighed on the nation’s output last year. In 2012, not only have those been recurring issues, but increasing costs coupled with low metal prices are pushing the industry closer toward its breaking point.

Last week, Aquarius Platinum (ASX:AQP,LSE:AQP) said its Everest mine is being placed on care and maintenance, making it the second mine closure the company has announced in recent weeks.

Following a four-day shutdown, trading of Platinum Australia‘s (ASX:PLA) shares was suspended on Monday. The company is conducting a review of the strategy and viability of the Smokey Hills mine because “difficult operating conditions” are preventing the company from achieving its forecast production.

The South African supply situation is looking ever more shaky and could become worse than many have anticipated.

According to A-1, an intermediate price range of $625 to $725 for palladium may be warranted given current new car registrations.

Further price appreciation to $775 to $800 will need to be supported by a clear indication of a resumption of growth in China, stable expansion in the US, and a more positive outlook for the EU countries, according to A-1′s May market review.

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