By Ivan Y.
While gold and silver receive all the attention from the media, platinum and palladium have outperformed both of them this year. But the point of this article is not to compare these two metals with gold and silver. Rather it is to try to explain why palladium has outperformed platinum this year. Platinum is down 6% year-to-date while palladium is up by 4%. The platinum-palladium ratio is now slightly below 2. The ratio was above 2.3 for most of 2012.
There are two things that both platinum and palladium have in common. First, both metals are expected to experience a supply deficit in 2013. For platinum, the deficit is expected to be 844k ounces. For palladium, the expected deficit is about 1 million ounces.
Second, both metals are critical components in catalytic converters used to reduce emissions from automobiles. On average, an auto-catalyst contains about 4 grams of platinum or palladium, which works out to about $140 for each vehicle based on an equal weighting of both metals. For gasoline vehicles, platinum and palladium are interchangeable. Thus, palladium is the metal of choice for gas vehicles because it is 50% cheaper. However, for diesel vehicles, platinum is the metal of choice because diesel exhaust contains sulphur dioxide. Some amount of platinum can be substituted by cheaper palladium in diesel vehicles, but current technology only makes a mixture of around 70% platinum and 30% palladium practical. You can expect those percentages to work more in favor of palladium as technology improves. In the future, something closer to a 50-50 mix can be expected. So how does that information relate to palladium's outperformance this year? Well, it all comes down to economic growth and the types of cars people around the world buy. In the U.S. and China, the overwhelming majority of cars sold are gas-powered. In the U.S. specifically, the percentage of new diesel cars sold is less than 5%. The situation for diesel is much different in Europe. More than 40% of the cars bought there are diesel-powered. Why do Europeans love diesel? For one thing, government taxes on diesel are much lower.
Platinum can thus be thought of as a bet on the European economy, while palladium can be thought of as a bet on the economies of the U.S. and China. Car sales in the first six months of the year were up year-over-year in both the U.S. and China. For China, passenger car sales were up 13.8%. Unfortunately for platinum, European car sales through the first six months of this year were down 6.6% compared to 2012. This is not surprising since Europe continues to struggle through its economic problems.
In summary, palladium is outperforming platinum this year because it has a slightly larger supply deficit and because the European economy has hurt platinum demand in diesel vehicles.
Although both metals should perform well in the long term, I believe that the long-term trend favors palladium over platinum. Besides the platinum ETF (NYSEARCA:PPLT) and the palladium ETF (NYSEARCA:PALL), investors can also consider the closed-end fund from Sprott (NYSEARCA:SPPP). SPPP holds both platinum (30%) and palladium (70%). The fund currently trades at a slight discount to net asset value. For those who prefer the miners, there are few to choose from. The only two North American miners are North American Palladium (NYSEMKT:PAL) and Stillwater Mining (NYSE:SWC). PAL is a high-risk stock due to its very poor financial position. For example, recently, in order to secure a much needed loan to pay off existing debt and to fund a mine expansion, the company had to agree to pay a 15% interest rate. With a stock price near $1, PAL is probably not suitable as an investment for many investors. Its debt/equity ratio was .62 at the end of last quarter, but that doesn't include the new debt from the recent financing. SWC has a more solid balance sheet and is the safer investment. Its debt/equity ratio at the end of last quarter was .26, which is relatively low for a mining company. SWC is expected to produce 500k ounces of palladium and platinum combined this year from its Montana mines. An overwhelming majority of that production is palladium. It also has a recycling business that generates about half its revenue, but contributes little to income. SWC has already rallied more than 20% in the past several weeks. I don't see it as a great bargain right now. Something closer to $10 would make the stock a more compelling buy.
Disclosure: I am long SPPP. 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.