Are palladium stockpiles running out?

In early April, palladium prices attempted a run at the $800-per-ounce level, but were thwarted — quite likely — by the collapse in gold prices. Chart 1 shows that palladium was moving independently, responding to what have become very bullish supply/demand fundamentals. At about the same time that gold peaked at $1,750 per ounce back in October, palladium began a close-to-$200-per-ounce rally that held right up until gold broke below $1,600 per ounce. Palladium could not withstand the winds of liquidation.

Palladium may be rare, but it is not a precious metal, at least not in the same sense that gold is, because its investment sector is negligible. While volatility in gold prices may affect palladium prices in the short term, palladium should not be beholden to the broad precious metals investment climate.

Just about all available palladium supplies are used for industrial purposes. About 70% is used as a catalyst for the exhaust systems of motor vehicles. The balance is used by the jewelry, chemical, and dental industries.

Palladium has taken auto catalyst market share from platinum over the past 10 years. Johnson Matthey (JM) estimates 2012 global platinum auto catalyst demand at just over 3 million ounces. That’s down from the 2007 peak of more than 4 million ounces. Palladium demand during this period, on the other hand, experienced explosive growth. JM estimates 2012 usage at 6.5 million ounces, up from 3.5 million ounces in 2003.

The bullish case, however, is not strictly a demand side issue. The market is absorbing a supply-side shock from two fronts. Roughly 80% of world supplies are mined in two countries, Russia and South Africa.

About 45% of annual global supplies come from Russia. In recent years, about two thirds of Russian supply was newly mined, with the balance coming from stocks. Between 2005 and 2011, Russian exports from inventory averaged 900,000 ounces per annum, or about 11% of total world demand. In 2012 that number shrank to about 250,000 ounces, representing only 3.3% of global demand. Although the actual size of the Russian stockpile is a closely guarded state secret, industry analysts believe that there are little or no stocks remaining.

There are new mining projects that will eventually produce more palladium, but we are talking about 10 years down the road.

To complicate matters, serious labor strife in the world’s second largest supplier has debilitated some key mines in South Africa. Strikes at Anglo American Platinum Ltd. mines have caused the company to pare back production, eliminating a significant amount of production from the market. The company is in talks with the government about closing some mines indefinitely, but either way, supply will be curtailed for the foreseeable future.

As a result of these supply issues and growing demand, there was a global supply/demand deficit of 915,000 ounces in 2012, a complete turnaround from a 1.26-million-ounce surplus in 2011.

Palladium prices have increased substantially vis-à-vis platinum prices since mid-2009. Where substitution is an option and the cost is an issue, platinum might have priority. Chart 2 shows that palladium prices were much higher in the early 2000s, but then again, the explosive growth in auto catalyst demand may have only been facilitated by much lower palladium prices we saw between 2003 and 2009. So demand could prove to be elastic to some degree, especially if prices continue to rise.

We believe, however, the recent selloff was an overreaction to the general drop in metal prices. The instability of supply lines from both Russia and South Africa remains the dominant issue. South African mine production will not grow anytime in the near future. And if Russia has indeed depleted its stocks, we will be looking at another global supply/demand deficit in 2013

Prices will need to move much higher to incentivize infrastructure investment. Even so, in the near term, supplies will remain very tight, and we expect prices to rebound back to the highs and beyond.

Buy June palladium. Places sell stops at $650 per ounce, basis June, close only. This is a very illiquid market. We recommend a conservative trading approach.

About the Author
Sholom Sanik is an analyst with Friedberg Mercantile Group Ltd. He can be reached at ssanik@friedberg.ca