Dwindling Supply Means Palladium Is Ready To Shine

by: Tony Daltorio

Wall Street tends to lump all precious metals together, usually in connection with the word "short", no matter the fundamentals. But for contrarian-minded investors, that can create opportunities.

This is especially true right now with the precious metal that is most often overlooked ... palladium. The metal is used mainly in catalytic converters on gasoline-powered vehicles to limit the pollution these vehicles emit. Platinum is used in a similar fashion for diesel-powered vehicles.

Demand from the automotive sector (accounting for two-thirds of demand) and other industries is stable to a bit higher currently, after doubling over the past 10 years. Vehicle demand in China and the United States is the main driver behind rising consumption of palladium.

But that is not where the excitement is. An upward move in the palladium price will come from the interesting dynamics occurring on the supply side of the equation.

Palladium Supply Dwindling

According to Thomson Reuters GFMS, the palladium market recorded its highest deficit in 11 years - 1.122 million ounces - in 2012. Palladium deliveries were about 8.7 million ounces while demand was 9.32 million ounces.

Roughly three-quarters of that amount were produced by palladium mines, with the remainder coming from other sources. The two countries responsible for nearly 80% of the world's mined palladium are Russia and South Africa.

This is part of the problem according to the GFMS Platinum & Palladium Survey. Russian production continued its steady decline (down 3% in 2012).

Meanwhile mining companies in South Africa are facing both high costs and growing labor turmoil. Last year, 250,000 ounces of palladium production were lost as a direct result of the labor unrest. That translates to a 10% decline from 2011.

The real key for investors, however, is that the source of supply that has always bailed out the palladium market in times of shortages may soon be gone.

The Russians Are Not Coming

This source of palladium is the Russian strategic supply of the metal. Russian inventory sales dropped sharply last year by 68% from 775,000 ounces in 2011 to only 250,000 ounces, according to Johnson Matthey.

The precious metals consultancy is forecasting that the Russians will sell less than 100,000 ounces from the stockpile in 2013. Peter Duncan, general manager of market research at the firm, told reporters in January that "Russian state stockpiles have been dwindling and are now pretty much exhausted."

Thomson Reuters GFMS is in agreement with the assessment of Johnson Matthey. Research director for mining at the company, William Tankard, said "we are of the view Russian sales from historical inventory halved last year, and speculate that 2013 could well mark the end of this source of metal from behind the curtain."

If Tankard is correct, 2013 will be a landmark year for palladium. The massive Russian stockpile of the metal may well be gone at a time when mined supplies of palladium are shrinking and simultaneously, demand is rising due to increased demand for cars in the emerging world.

By far, palladium has the best fundamentals among the precious metals group.

Palladium Investments

This presents some profit opportunities for sharp-eyed investors. For individual investors looking to make money from this long-term trend, exchange traded funds offer an easy way to do so.

The first ETF is the ETFS Physical Palladium Shares (NYSEARCA:PALL), which as the name implies investors in physical palladium bullion. It holds the bullion in vaults in London and Zurich, which are audited twice a year. Its expense ratio is 0.60% per year.

A second and more recent investment vehicle is the Sprott Physical Platinum and Palladium Trust (NYSEARCA:SPPP), which owns both platinum and palladium bullion. Its bullion is held in vaults in London, Zurich and Canada. Its total annual expenses are 0.85%. The interesting twist here is that shareholders can actually redeem their shares for physical bullion on a monthly basis (minimum of 25,000 units).

Another option is the world's largest miner of palladium, Russia's Norilsk Nickel (OTCPK:NILSY). One caveat though. The company is the subject of a epic struggle between two Russian billionaire oligarchs - Vladimir Potanin and Oleg Deripaska. Even the attempts at conciliation by the Russian government and other oligarchs has proved futile in completely settling the dispute. The ongoing antagonism is sure to act as a continuing drag on stock performance

The ETFs investing into the metal itself seem to be the safer way palladium.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.