Seeking Alpha
Long only, deep value, special situations
Profile| Send Message|
( followers)  

OVERVIEW

Palladium is a rare precious metal that belongs in the platinum metals group with unique physical properties that are used in diverse industrial applications and in jewelry. The unique characteristics of this group include strong catalytic properties, excellent conductivity and ductility, resistance to corrosion, strength and durability, and a high melting point.

Demand for palladium is widely diversified by geography and end market. The primary uses are the manufacturing of catalytic converters used in the automotive industry, jewelry and electronics and in dental and chemical applications. There is also investment demand for palladium which is typically held as physical inventory by exchange traded funds (ETFs) and institutional investors.

Palladium production is typically a by-product from platinum mining operations. South Africa is currently responsible for approximately 38 percent of world mine production. Norilsk Nickel's mines in Russia account for approximately 41 percent of world mine production and North America contributes approximately 14 percent to the world's supply.

Palladium is currently trading at the highest levels since 2001 and is projected to remain strong through 2017 as the supply deficit is expected to persist in the future. The outlook for palladium over the next ten years predicts a return to historically high prices, strong fabrication and investment demand, and constrained supply.

SUPPLY CONCERNS

Global palladium supply consists of mine production combined with secondary recovery which is derived by recycling. In 2012, the supply of palladium was approximately 8.7 million ounces with approximately 6.3 million ounces from mine operations and 2.4 million ounces from secondary recovery.

Palladium is a rare precious metal with only a few palladium producing regions worldwide and even fewer ore bodies where it is economically feasible to mine and extract the metal. As mentioned earlier, Russia and South Africa account for almost 80 percent of global mine palladium production. However these regions are known to be higher-risk jurisdictions.

Growth in mine supply, which contributes the largest amount to the world's overall supply, will face a number of headwinds in the near term. Specifically, there linger political, infrastructure and cost issues in South Africa, declining production in Russia and a limited number of new projects expected to commence production in the near term.

When looking at production growth from South Africa, it is challenged by the need for deeper mines, limitations associated with power and water, higher operating costs, geopolitical risks, shortage of skilled labor and the strengthening of currencies. There are no immediate solutions in place to remedy or subdue these risks and the South African mining industry has already started to contract with over 250,000 ounces of palladium lost in 2012, a direct result of operations closing due to labor unrest. These problems which are expected to continue coupled with rising mining cash costs will likely limit palladium supply from South Africa in the immediate and near term.

Secondary supply is derived from recycling and from a Russian government stockpile. These government palladium stockpiles have historically been a major overhang on the market and there has been considerable speculation surrounding the amount of their current holdings. While the total amount is not known, forecasters have recently indicated that the Russian stockpile has declined to relatively low levels and will no longer be a significant contributor to the palladium market going forward. This decline in secondary production has contributed to the supply deficit.

According to Barclays, supply from mines and stockpiles will rise 0.3 percent this year after contracting almost 11 percent in 2012.

STRONG DEMAND GROWTH

The growing demand for palladium has been primarily driven by the automotive sector's growth, which consumes approximately 67 percent of the world's palladium supply. The metal is used in the manufacturing of catalytic converters (mufflers) for cars which help reduce automotive emissions in the environment.

Over the past ten years, demand for palladium in the automotive industry has more than doubled due to increases in production and the tightening of emissions standards worldwide, resulting in steady growth in the use of catalytic converters. The average catalytic converter contains around 4 grams of palladium

The automotive sector growth is stemming from the emerging economies including China, India, Brazil and Russia. The growth in these regions is attributable to growing middle and upper classes, the extremely low penetration of vehicles per capita and their increasing affordability due to low interest rates and leasing programs. In 2012, global car sales exceeded 80 million for the first time ever and will advance 2.4 percent to 82.7 million in 2013 according to LMC Automotive Ltd., a research company in Oxford, England. In November, car sales in China, which is now the world's biggest car market, rose nearly 9 percent year on year to almost 1.5 million units as its economy recovers from the recent slowdown. Light global vehicle production is forecasted to increase at a compound annual growth rate of 4 percent to over 100 million units by 2017, with most of that growth driven by the BRIC economies.

The key factors which will affect palladium demand into the near to mid-term include increasing vehicle production, stricter emission controls that mandate the use of catalytic converters, the recent growth in palladium exchange traded funds (ETFs) which have significantly contributed to the increased investment demand, and technological advancements for palladium's use in diesel catalytic converters, which can now substitute about 30 percent of its platinum content with palladium

Barclays estimates that during 2013, palladium consumption will beat production by 511,000 ounces, which is the equivalent to what the car industry uses in approximately seven weeks. Additionally, Morgan Stanley expects deficits to persist until at least 2017 and predicts a record annual price average in 2014.

SPOT PRICE

As of the time writing this article, the palladium spot price is approximately $705, 37 percent below the record high of $1,125 an ounce it reached in 2001. In 2012, the average price for palladium was $638 with the average year price expected to be $744 in 2013, an increase of 16.6 percent. The average spot price for 2014 is forecast to be $925, an increase of 24.3 percent from the 2013 forecast and a 44.8 percent increase from the 2012 average price.

INVESTMENT CONSIDERATIONS

The first possible investment to consider is to invest in an ETF that holds physical palladium similar to GLD and SLV for gold and silver respectively. ETFS Physical Palladium Shares (NYSEARCA:PALL) is designed to offer investors a simple, cost-efficient and secure way to access the palladium market. The fund focuses on providing investors with a return equivalent to movements in the palladium spot price less fees. This ETF is a great way to get pure exposure to this precious metal.

Another option is to invest in a palladium miner such as North American Palladium Ltd. (NYSEMKT:PAL). The Company is in the business of exploring and mining palladium, platinum, gold and certain base metals, and has been operating its flagship Lac des Iles mine located in Ontario, Canada. Its vision is to become a low cost, mid-tier precious metals company operating in mining friendly jurisdictions. During the first quarter of 2013, the company produced 38,654 ounces of palladium at a cash cost of $490 per ounce with a realized selling price of $730 per ounce. While investing in miners typically gives you leverage to a precious metal it also presents additional risks such as correlation to the overall market and the efficiency that the business is run. PAL is a small capitalization company at $195 million. Additionally the company posted a net loss of $0.02 per share in first quarter of 2013 expanding from a net loss of $0.01 per share in the first quarter of 2012.

Stillwater Mining Company (NYSE:SWC) is engaged in the development, extraction, processing, smelting, refining and marketing of palladium, platinum and associated metals (platinum group metals) from a geological formation in south-central Montana known as the J-M Reef. SWC has a market cap of approximately $1.4 billion and reported net income of $14.6 million, or $0.12 per diluted share in the first quarter of 2013 compared with $5.9 million or $0.05 per diluted share in the prior year period. The company produced 127,100 ounces of palladium and platinum during the first quarter of 2013, a 5.2% increase from the 120,800 ounce production in the first quarter of 2012 with an average cash cost of $523. Stillwater also realized a quarterly record in recycling ounces at 154,200.

CONCLUSION

In the precious metals space the majority of the attention is placed on gold and silver. If you are looking at an alternative or to diversify your precious metals investments palladium is worth a further look. It is one of only a few metals that are currently experiencing supply deficits which could be the driver causing prices to rise dramatically.

Source: Palladium Supply Deficit Likely To Continue Until 2017