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At the height of the recent financial crisis, it appeared that one of the oldest and most iconic American industries would become one of the biggest casualties. The automotive industry was already reeling from a major dip in demand for its most profitable products when gas prices surged, and the dawn of one of the worst recessions in a generation only exacerbated the struggles. As households and businesses began slashing their budgets, demand for the ultimate consumer product fell off a cliff. Beyond the macroeconomic issues, smaller problems added up to take a toll on the bottom lines of companies that had once been among the most profitable in the world; glitches in Ford’s accounting software resulted in employees receiving paychecks long after they left the company, while General Motors squared off with unions on multiple occasions.

Against such a dismal backdrop, the proposed bailout of the automotive industry became an incredibly controversial package. With a collapse of the industry seemingly underway, the odds of recouping a taxpayer investment in the automotive sector were unacceptably low to many who opposed lending money to sinking ships at General Motors and Chrysler (Ford never accepted any federal bailout money).

But now it appears that those ships have been righted. GM has taken to the airwaves to make it known that the firm has repaid its federal loan with interest five years ahead of schedule. Chrysler recently reported a huge improvement in its operating results; after losing $3.8 billion in the second half of 2009, first quarter losses were cut to $187 million and operating profit before interest and taxes was actually $143 million. CEO Sergio Marchionne called the results “a concrete indication to our customers, dealers and suppliers that the 2010 targets we have set for ourselves are achievable.”

The good news isn’t just limited to auto manufacturers. AutoNation, the largest U.S. auto dealership group, beat Street estimates with first quarter earnings this week, noting that a U.S. auto industry recovery is well under way. “This recovery will continue throughout the year because all the major structural issues that we look at are improving,” Chief Executive Officer Mike Jackson told Reuters. Jackson also expects U.S. sales to return to pre-recession levels within four years.

Palladium ETF: A Play On A Sustained Recovery

With four ETFs offering exposure to the semiconductor industry and targeted products focusing on everything from gaming to shipping companies, it is perhaps surprising that there is no U.S.-listed automotive ETF (at least not yet–Direxion recently filed details on its proposed Auto Shares product). But that doesn’t mean there aren’t ways to play a recovery in the automotive industry through exchange-traded products.

Two of the year’s most successful new products, the ETFS Physical Palladium Shares (NYSEARCA:PALL) and Platinum Shares (NYSEARCA:PPLT) present a unique way to bet on the auto sector not through stocks, but rather by investing in precious metals. PALL and PPLT are physically-backed ETFs that invest in palladium and platinum, respectively. Both of these metals are among the rarest in the world, with average annual production of about eight million ounces.

So why might the price of a palladium bar be tied to the prospects of the automotive industry? The primary use of both platinum and palladium is in catalytic converters, a component of automotive exhaust systems that converts harmful chemicals to less-toxic substances. About half of the global demand for platinum and palladium comes from the auto industry, which forges the correlation between the spot price on the metal.

A recent report from metals consultancy GFMS highlights this relationship. “Amid last year’s turmoil, autocatalyst and industrial demand for platinum and palladium was exceptionally depressed in early 2009, as output was cut drastically and expansion plans abruptly curtailed,” GFMS said in the report. “With the worst of the economic crisis having passed by mid-year, a recovery in these areas got under way.”

So when demand for new vehicles slides, so too does demand for platinum and palladium. As production volumes were slashed as the auto industry began to shrink, the prices of platinum and palladium dropped as well. As the outlook for carmakers has improved, prices of these metals have soared; PALL was recently up about 30% since its launch in early January while PPLT has added about 9% over that period.

Of course the price of palladium depends on other factors besides the health of the automotive industry, and achieving synthetic exposure to equity markets through commodities comes with some risks.

Disclosure: No positions at time of writing.