Jessica Cross: Power Disruptions Could Drive PGM Prices Higher

by: Hard Assets Investor

By Lisa Barr

South Africa, one of the world's primary precious metals producers, continues to struggle to meet its own growing electricity needs—and there's little relief in sight, says Eskom. Earlier this week, the state-owned power utility, which accounts for 95 percent of the country's electricity supply, projected that unless more power plants are built soon, the nation could face severe power supply shortages in 2011-13 and beyond. Of course, this would cripple the country's mining industry, which, according to Johnson Matthey, accounts for some 78 percent of the world's platinum, 35 percent of its palladium and 87 percent of its rhodium supply.

But Eskom's announcement could impact the precious metals market well before 2011, says Jessica Cross, CEO of VM Group. Working in conjunction with Fortis Bank Nederland, VM Group provides research and analysis of the metals and broader commodities markets, including precious and base metals, energy, agribusiness and renewables.

In this first of two interviews, HAI Associate Editor Lara Crigger sat down with Cross to discuss South Africa's power troubles, including what ripple effects the news could have on automakers, how PGM ETFs have affected the market, and what difference a flooded mine shaft makes.

Crigger: What consequences would ongoing power disruptions in South Africa have on the precious metals markets?

Cross: It could be very serious, particularly for the PGMs [platinum group metals], not so much for gold. Well ... South Africa is not the biggest gold producer anymore, but it is still up there, so any loss of production will certainly impact that market, too. But the real question is, what happens to PGMs? The world needs PGMs for autocatalysts, and primarily, South Africa is the main producer.

So obviously, any break in power supply to the mines is of very serious consequence, particularly for your deep hard-rock mining. If you have a prolonged power cut, chances are that those mines could flood, and the cost of trying to de-flood them is enormous.

So it's not just a question of the power going out and coming back on tomorrow, and it all gets sorted out; this has long-term consequences for PGM and gold capacity. It's very serious.

Crigger: When a mine floods, how long does it take to de-flood it?

Cross: Well, very often, they don't even do it, because it just proves to be so expensive. It depends on the age of the mine, the depth of the shaft and how much life is left is in that shaft. In the end, you really, really don't want to flood a shaft. It could take months to get that right, and everythingbasically, your equipment, the shaftall gets decommissioned.

So any announcement from Eskom along these lines makes one sit up and think what's going to happen to PGM prices.

Crigger: Something like that would certainly lend long-term support to PGM prices.

Cross: Absolutely. And I'm sure PGM producers are in intense discussion not only with their management, but also the government. Obviously, mining is crucial to the South African economy; it's all intertwined and interrelated. It has implications in South Africa for employment. But a regular and reliable source of power is core to that industry and the economy, and really they can't afford to have a problem like this re-emerging.

Crigger: It's interesting, because the platinum and palladium markets are so much smaller than other precious metals markets. So an announcement like this has the potential to dramatically drive prices.

Cross: It certainly does. I think once investors pick up on this it will create a knee-jerk reaction, because of South Africa's dominance as a producer of PGMs, but also as you said, the markets are that much smaller, and people know that the PGMs are very instrumental in the control of exhaust emissions.

Crigger: Speaking of which, how do you see power disruptions affecting the auto industry, especially with the current recovery in automobile demand?

Cross: Well, it's interesting that they're happening at the same time. You could have a double whammy. You've got very strong car registrations in China, and a recovery in Europe, a recovery in the U.S. It's all primarily gasoline-driven cars, too, so you're not seeing many electric cars coming in that don't use platinum or PGMs at all. The market penetration isn't there, and we don't see that happening for the foreseeable future.

So we're still very much relying both on diesel and gasoline catalysts, both of which require PGMs in different ratios. The procurers of these metals for the car manufacturers are left in a difficult situation, because they're obliged to procure metals for long-term plans and production lines, but they have to do that not only amid rising prices, but also volatile prices. That's very difficult.

Crigger: There's another factor, too, here, and that's the platinum and palladium ETFs. Europe has had physically backed PGM ETFs for awhile, but in the U.S., PPLT and PALL just launched, and they're very popular. How do you see ETF investment affecting demand in this sector moving forward?

Cross: All the precious metals ETFs are doing particularly well. They're the right products at the right time in the right place. They're allowing investors to participate in this commodities cycle in a way that they couldn't do before.

Clearly, if you have a sharply rising PGM price because of the Eskom factor in South Africa, you're going to see more interest in these ETFs. People who got in early are obviously going to do very well with their investments. So I think the Eskom factor could raise the volatility of the ETFs, raise the turnover and it will lead to more investors coming in as a consequence.

Crigger: Do you see the ETFs having a disproportionately large effect on the platinum and palladium markets, compared to something like GLD and gold?

Cross: I think you're getting a slightly different sort of investment coming in, but it's a very savvy investment. I think, yes, the ETFs are a very significant bottom line in your demand/supply balance, and this will instill volatility. So not only could there be upward pressure on PGM prices, but you'll see a roller coaster of very sharp up and down movements, as this thing continues to play out.

That in itself gives investors a fantastic opportunity to trade. There's nothing more boring for an investor than a very stable price that moves a tiny percent over a certain period of timeit's like watching paint dry. Of course, you could lose your shirt very quickly, too! So I'd say PGM ETFs are not for the faint of heart, and they're not for the inexperienced. But there are enormous opportunities coming in this industry.

Be sure to check back next week for Cross' thoughts on the silver market.