Shine On

Supportive fundamentals have made palladium the favored metal among speculative investors in recent years, as it has become the most commonly used of the platinum group metals (PGMs) in autocatalyst manufacturing worldwide, even in the European Union, where diesel engines account for about half of all new car sales. Continued strong vehicle sales in China, improving U.S. car numbers and increasing usage in diesel converters in Europe have buoyed commercial demand for the metal.

The market’s expectation for increasing worldwide car sales explains in part the recent appreciation in the price of palladium as commercial demand improves but perhaps does not fully justify the recent move to new cyclical highs of $830 per ounce, its highest level in 10 years and representing a doubling in value since the start of 2010. On commercial demand alone, it could easily be argued that palladium is overvalued at this time. But it is this significant growth in speculative demand that is credited with the sharp gains for the metal during the past year, as fund investors tend to oversubscribe to the same attractive opportunities. Investment off-take has evolved in recent years to represent a sizable and increasingly important new sector of demand for the PGMs.

CLIMBING SLOWY
As of January, total palladium held on behalf of investors in ETFs (exchange-traded funds) increased to 2.29 million ounces, with an additional 1.6 million ounces accumulated on the CME (Chicago Mercantile Exchange). For platinum, ETF holdings had risen to 1.28 million ounces as of January, with CME/NYMEX (New York Mercantile Exchange) non-commercial and non-reportable positions adding another 1.7 million ounces.

But U.S. car sales do appear to be recovering, albeit slowly, along with the sluggish growth expected in the U.S. economy. U.S. vehicle sales for 2010 rose by 10.6 percent back to 11.5 million units, up from the cyclical low of 10.4 million set in the prior year but still well below pre-recession levels of 16.1 million in 2007 and the 17 million in sales in 2005. The robust growth in Chinese sales in recent years has more or less compensated for the U.S. loss, gaining 5 million in new passenger car sales annually when measuring 2010 sales against those of 2007. The decrease in European car sales in 2010 to 13.36 million cars, resulting from the expiration of the scrappage schemes of 2009, was offset by higher Japanese domestic sales, rising to 5 million sales last year. Overall, global car sales likely improved by 13 percent in 2010 back to 68 million vehicles and could possibly top pre-recession annual sales of 70 million units in 2011.

Data from past economic cycles would suggest that the present recovery period in the U.S. is only about one-third complete. Given the implementation of the U.S. Federal Reserve’s QE2 program, what it has termed its current bond-buying program, and the continued climate of near-zero interest rates, the pace of the current mediocre expansion may be expected to improve in 2011 and again in 2012. Both Federal Reserve Chairman Ben Bernanke and Lawrence Summers, head of the U.S. National Economic Council, are projecting improved, but perhaps optimistic, growth in calendar 2011 of 3.5 percent to 4 percent. Automotive demand for palladium, along with consumer off-take for electronic and other industrial applications, may be expected to continue to recover in tandem with the economy.

PRODUCTION RAMPS UP
Another factor in palladium’s stellar performance since mid-2010 has been the market’s perception that the overhang of significant stocks of metal held by the Russian state repository Gohkran may be all but depleted. It was noted in comments from management at Norilsk that Russian state fund stocks have been on the decline in recent years and that, while no official announcement has or likely will be made, it is believed that there may be a significant reduction in metal offered to the markets in 2011 and beyond. More than 1 million ounces of palladium from Gohkran stocks annually are believed to have been sold onto the market in recent years. The cessation of these stock sales would likely put the palladium market in deficit in 2011 for the first time in many years.

An anticipated increase in primary mine supplies of more than half a million ounces of palladium in 2011 should partially offset the possible loss of Russian stock sales going forward. Production at Norilsk improved last year in tandem with the rise in metal prices and will likely exceed 3 million ounces of palladium in calendar 2011, up by some 200,000 ounces from 2009 totals.

PGM production at Vale was minimal in 2010, as mining of the company’s Sudbury operations only recommenced in September of last year following a labor strike that lasted nearly a year. The first production of PGM concentrates at Vale will likely be available for sale in the first quarter of 2011. Vale produced 411,000 ounces of PGMs as by-product materials in fiscal 2008, including 238,000 ounces of palladium and 173,000 ounces of platinum, in its last year of full production.

North American Palladium produced 95,000 ounces of palladium in 2010, with operations at the Lac des Iles mine restarting in the June quarter after being mothballed in October 2008 because of falling prices. The company has targeted output of 170,000 ounces and 190,000 ounces of palladium over the next two-year period respectively.

GROWTH IN SCRAP
The supply of automotive scrap also is projected to show substantial growth this year, as higher metal prices encourage the collection of salvage material. Palladium sourced from the recycling of scrapped catalytic converters could see a 20 percent increase in 2011, perhaps rising to 1.35 million ounces. This would be a record high level and third in size only to Russian and South African primary mine production.

The price of palladium has now risen to its highest level in 10 years, since the metal spiked to more than $1,100 per ounce the last time supplies of palladium from Russia were restricted. The market’s assessment of a potential loss of what has been estimated to be as high as 1 million ounces of palladium each year from Russian stocks may have resulted in a similar supply shock to the marketplace as that recorded in 2000/2001. Based on the market’s expectation of this potential deficit in palladium supplies, firming global automobile sales and significant fund buying, palladium prices are expected to rise further, at least through the first half of 2011, possibly crossing above $900 per ounce and perhaps even spiking briefly to near $1,000 per ounce.

But the recent pace of annual price appreciation in palladium is not sustainable. And with the presence of such large speculative positions in palladium coupled with cyclical high values, any bouts of negative market intelligence could spark quick and even volatile corrections in price. So far these corrections have been short lived and ostensibly viewed as buying opportunities. But investors may grow increasingly concerned that with the price of palladium already rising five-fold in just the past 24 months, the upside potential in value may be limited as metal prices appreciate to $900 and above.

Forecasts for further worldwide economic growth and improving car sales are likely already discounted in the present value of the metal. And absent any unforeseen surprises to the market, the probable winding-up of various national stimulus programs later this year, particularly in the U.S. and EU countries, continued recurrent rate increases in China and the start of a new upward phase in the rate cycle globally would adversely affect metal prices, causing the large investment component of demand to reduce holdings in the precious metals in search of more attractive alternative ventures.

By Patrick Magilligan, Ashok Kumar and Rajesh Seth
A-1 Specialized Services & Supplies, Croydon, Pa., can be found online at www.a-1specialized.com or contacted via e-mail at info@a-1specialized.com.