How New Palladium, Platinum ETFs Will Change Supply and Demand

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 |  Includes: PAL, PLG
by: Michael Pollick

The world is about to entertain two new investment vehicles that could have a profound effect on the prices of two very rare and very necessary metals -- palladium and platinum.

Unlike gold, which we do not "need" for that many purposes, platinum and palladium not only make for pretty jewelry but are essential to various chemical and electronic processes. Crucially, one or the other of these two metals must be present as a catalyst in a catalytic converter for an internal combustion engine, whether diesel or gasoline powered.

To cut to the chase, two new ETFs will make it possible for the first time for U.S. investors from Joe Six-Pack to El Magnifico Hedge Fund to buy and sell physical palladium or platinum bullion with the click of a mouse.

Both new ETFs will be traded on the NYSE and both are being marketed by the same company that has a major track record with European versions of these funds and others, ETFS Securities. Roughly speaking, 5 to 10 percent of world supply of each metal could be skimmed off the top of the market and salted away in vaults in the first year. We are waiting for final SEC approval at the moment, and the backers are making ready to sell shares to the public.

Before this, palladium and platinum were available in the U.S. through purchase of physical bullion at places such as Kitco.com, or through futures. With these ETFs -- as with the existing GLD and SLV ETFs -- you or I will be able to buy and sell physical bullion with the click of a mouse, and without major storage or insurance costs.

The most common form for retail purchase is one-troy ounce legal tender coins minted by governments such as the Royal Canadian Mint. At present, a platinum Maple, which is what the Canadians call their precious metal coins, retails for

U.S.$1,667 and a palladium Maple goes for $467. The retail prices are 8-9 percent above the spot prices.

Before this, a U.S. trader could also buy one of two platinum ETNs. The way these work is that the fund acts as if it owns platinum but does not really own it, just settles as if it did. There has been no ETN in the U.S. for palladium.

So these two new securities -- ETFS Palladium Trust and ETFS Platinum Trust -- really are a breakthrough for the still huge, omnivorous U.S. market.Compared to gold and silver ETFs, the crucial difference in my view is that these two new ETFs are dealing in metals which are six times more rare than gold.

Both of these precious metals have made sharp recoveries during the past year after falling apart with the general market in 2008. I remain bullish on both metals. But rather than investing directly in either of the two new funds, I choose to own stock and warrants in North American Palladium PAL/PDL.TO and Platinum Group Metals PLG/PTM.TO.

As an investor holding leveraged bets on palladium and platinum mining companies, what I want to know is how much metal can these funds take off the market and what percentage of the global yearly supply that represents?

Admittedly, there is a lot of guesswork involved, but I think it is possible to come up with ballpark answers.

My sources are the two prospectuses which I pulled from Edgar Online and the Johnson Matthew Platinum 2009 Interim Review, published in November and made freely available by JM on the net.

Like the other physical metal ETFs, these two will buy and sell "baskets" of metal in predetermined sizes in order to handle liquidations and purchases. They are not limited on how much they can buy. It is whatever the market will bear.

Each trust prospectus states that the trust will be terminated and liquidated if it does not have at least $350 million on its books after the first year.

The ETFS Palladium Trust (NYSE: PALL) starts out by selling $250 million in shares. Then it has to accumulate whatever amount of palladium that will buy and store it in a vault.

The ETFS Platinum Trust starts out at $500 million.

What I did was pick round numbers at which they might conceivably purchase the two metals and divide that into the initial and one-year overall million-dollar numbers discussed in the two prospectuses. This is not brain surgery, but I haven't seen anybody else doing it. I find this curious, but I have long been amused by the establishment media's odd dance with precious metals.

Figuring around U.S.$450 per troy ounce palladium, PALL would have to have in its vaults 500,000 to 600,000 troy ounces right away and then would have to have nearly 800,000 troy ounces of Palladium after one year. I am guessing they would like to have 900,000 troy ounces of palladium on account by one year from now.

For platinum, let's figure around $1,600 per platinum troy ounce.

Taking the $500 million initial stock offer for the platinum trust and dividing by $1600 per troy ounce we come up with the guesstimate that they will buy 300,000 troy ounces immediately. They could stay open after a year with 225,000 troy ounces of platinum. I guesstimate they would like to have 400,000 troy ounces of platinum under management after one year.

Turning now to the Johnson Matthey Platinum 2009 Interim Review (published in November 2009 using September numbers), we can get a fair fix on global platinum and palladium supply and demand.

Platinum: Total global supply for 2009 is 6 million ounces and total demand is 5.9 million, so we can see that there is not a lot of extra supply to go around. I am not aware of any big new platinum mine coming on stream that is going to change that production number. In fact, it looks like peak platinum, if we can call it that, was in 2006 at 6.8 million ounces. Platinum is used in the petroleum industry and in industrial processes as well as jewelry, so JM breaks out categories of usage. Investment demand for 2009 was 630,000 troy ounces, JM figured.

Some of the investment demand will be usurped by the new fund, but some will not. It is likely that the new etf WILL increase investment demand by sophisticated investors by 20 percent. Fifty percent is possible based on the numbers. The same 300,000 starter ounces would take out 5 percent of the global supply.

Regarding palladium, even though it is much cheaper than platinum, the world does not produce much more. Total supply for 2009 is estimated at 7.2 million troy ounces. Production peaked in 2004 at 8.6 million ounces per year.

Overall demand, including chemical, dental, electronics, jewelry, investment and other, was 6.5 million troy ounces for 2009. Demand peaked in 2005 at 7.4 million ounces. (I think palladium demand is going to rise sharply because it is gaining market share in catalytic converters and because it is an essential catalytic component to fuel cells, which are only now beginning to come into practical use as a power source.)

Out of the overall palladium demand in 2009, JM guesstimates investment demand at 635,000 ounces, which turns out to be roughly the same as platinum investment demand! Remember we said that the ETFS Palladium Trust would need 500,000 to 600,000 troy ounces to start with? Just as with the platinum ETF, some of the existing investment demand will be usurped by the new fund, but it will create new . We just don't know how much. At the outside, it appears possible that the ETFS Palladium Trust will double investment demand for palladium.

There are a lot of moving parts to this puzzle. We do not know how much the new funds will simply steal existing investment demand away from other funds. Europeans might like these more because they offer improved liquidity, for example.

But there is something else to consider, which I call the media blab effect.

At present, most people have no clue that palladium and platinum are elements on the periodic table, or that they have industrial uses, or that you can buy them in coin form.

For lots of folks, Palladium is an old theater in London and platinum is what you pick for your wedding rings if you think gold is too common.

Because of these two ETFs, I predict that media outlets will be blabbing about two rare metals that most people know nothing about.

This will increase demand for palladium and platinum bullion coins that does not exist at present.

Since the coins sell at a premium, the effect will be take metal out of the industrial market permanently.

In other words, this new investment phenomenon could feed on itself.

Disclosure: am long PAL, PAL warrrants traded as PALWF, and warrants on Platinum Group Metals PLG which trade on the Toronto Stock Exchange as PTM-WT.