Editors' Note: This article covers a micro-cap stock. Please be aware of the risks associated with these stocks.
By Nathan Slaughter
If you want to be successful in the stock market, then sometimes you must think like a contrarian.
I've spent 15 years in the investment industry. In that time, I've seen many investors struggle and many others make a fortune.
The difference between success and failure usually has little to do with intelligence or analytical skills. Rather, the best investors generally have an ability to stay cool under pressure and the fortitude to break away from the herd when necessary.
This is the best way to make money when it comes to commodity investing.
Like many investors, I've been neutral to bearish for most precious and industrial metals over the past couple of months. However, there is one notable exception.
Before I tell you about this metal, let me give you some background on it first...
It's one the scarcest metals on the planet. In fact, for every 10 ounces of gold pulled out of the ground, only 1 ounce of this metal is taken out of the ground -- and gold is supposedly one of the scarcest metals on Earth.
This is exactly the sort of scarcity that can drive up prices; all that's needed is demand. And we're seeing that, too.
So what metal is going against the grain? Palladium.
What's going on with this metal is exactly what you should look for when seeking out a commodity to invest in.
Unlike gold, whose value hinges on fickle expectations for monetary stability, palladium prices are influenced by more predictable supply-and-demand fundamentals.
Even under optimum conditions, palladium mines have been struggling to keep up. Not to mention that last year labor disputes cut operations at several large mines, leading global output to fall 11%.
Additionally, due to rising costs, many producers have been forced to close less economical mines.
In years past, withdrawals from Russia's palladium stockpile could cover any shortfall, but those reserves are now thought to be nearly exhausted.
On top of the dent in supply is a dramatic increase in demand. Worldwide palladium consumption jumped 16% last year to hit a record 9.9 million ounces. And I expect equal or greater consumption in 2013 and beyond.
Palladium is an extremely important metal. In fact, I would say it's indispensable for the global economy.
It plays a key role in the automotive industry. They are essential to catalytic converters, which turn vehicle exhaust into harmless water vapor. Without these devices, internal combustion engines would spew out tons of noxious pollutants. That's why they are installed on almost every car and truck that hits the road.
And auto manufacturing is one of the few strong spots in an otherwise soft global economy.
According to LMC Automotive, an automotive industry market research firm, global vehicle production will rise 3.4% this year to 83.8 million vehicles. And growth is expected to accelerate 6% next year.
Keep in mind, auto manufacturers make up 65% of demand, but aren't the only hungry buyers anxious to get their hands on palladium. It's also found in iPods, Blu-ray players and flat-panel monitors, among other places.
Put the picture together, and you start to see why palladium has decoupled from other commodities, gaining ground at a time when just about everything else is retreating. I expect it to rise above the $800 in the coming year -- a 20% increase from current prices.
So what's the best way to invest in palladium? Rather than trying to invest in it directly, like all commodities, I like putting my money with miners pulling the stuff out of the ground.
For palladium I like junior miner North American Palladium (NYSE: PAL), which I'm expecting big things from over the next 12 to 24 months.
There are three main ways that a miner can boost cash flows and excite the market:
1) Fetch higher prices for its metals.
2) Produce and sell more of those metals.
3) Find a way to get them out of the ground for less.
An improvement in any of these areas can make a dramatic difference. I believe North American Palladium is positioned to achieve all three.
First, given the supply and demand factors I discussed above, I am confident palladium will continue climbing.
Second, North American Palladium is in the midst of redoubling its efforts to extract value from its flagship palladium mine -- located in Canada, one of the few mines outside of Siberia and South Africa. The property relinquished 163,000 ounces of palladium last year and has much more to give.
In fact, output is expected to rise to 250,000 ounces per year once expansion efforts end. That's an increase of 90,000 ounces annually -- nearly 60% above current production levels.
Finally, when production begins to expand, costs are expected to drop precipitously, diving to $250 per ounce by 2015 (versus $490 today). With costs falling and palladium prices rising, profit margins could surge to around $550 an ounce, from $240 per ounce today.
Multiply that $550 by an additional 90,000 ounces of annual production, and you start to see that North American Palladium has the potential to multiply its stock price several times over.
Granted, there are several variables that have to fall the right way for this bullish scenario to play out. But at less than $1 per share, the market is expecting very little from North American Palladium. Still, the stock is better-suited for risk-tolerant investors.
I think this could be one of the best ways to take advantage of global palladium supplies being stretched ever thinner. As more palladium begins flowing, the company will transition into a more efficient, mid-tier producer.