With precious metals broadly lower in 2013, many monitor platinum's recent lackluster performance with failing confidence in the bullish arguments that have been made in the past. This is highlighted by the choppy performance of platinum exchange traded funds like ETFS Physical Platinum Shares (NYSEARCA:PPLT) as well as in the platinum spot price. Undoubtedly there are platinum investors out there who have taken positions, or those who have been contemplating such positions, but are increasingly disillusioned as platinum has failed to respond to the litany of bullish arguments made for the metal over the years. 2012 and 2013 were characterized by platinum failing to sustain itself above $1,700, meeting significant resistance around the $1,725 to $1,730 level over the last two years.
Bearish rhetoric, oftentimes focused specifically on gold, can influence the public's perception of the broader precious metals space. Platinum's wide-ranging industrial applications and anemic global economic growth has similarly bolstered the bearish argument. However, despite performance to the contrary, the fundamentals that have been touted by platinum's proponents for years remain intact today - albeit with less prominence than they were afforded in the past.
The core arguments for higher platinum prices remain:
- Heavy concentration of global platinum production in South Africa
- Growing industrial demand and annual supply deficits
- High and rising cost of platinum production
Regardless of waxing and waning investor sentiments and an uncertain global economic outlook, these considerations have not disappeared and remain as compelling as ever. The caveat is time - who can say how long prices will remain distorted in relation to the aforementioned dynamics. However, for those investors with the patience and discipline to tolerate transient price fluctuations, current platinum prices may reflect an attractive entry point.
SOUTH AFRICAN CONSIDERATIONS
Chart 1 below depicts the staggering disparity between South African platinum production and that of the next largest producing regions. According to Johnson Matthey, South Africa was responsible for over 70% of the total platinum production in 2013. This significant concentration of annual production ensures that global supplies are heavily reliant on the success of the South African mining industry. As can be expected, this represents an observable risk to the continuity of annual production levels if, as we have witness many times in the past, South African mine operations are compromised. The primary threats to the unfettered operation of these mines are labor strife and the availability of electricity supplies.
Chart 1. Data Source: "Platinum 2013 Interim Review"; Platinum Supply by Region 2009-2013; Johnson Matthey; accessed February 5, 2014.
South Africa's history is rife with examples of social tension which did not end with Apartheid. The social conflict inherent to South African society is most certainly evident, if not exaggerated, within the nation's mining industry. Poor living and working conditions, perceived inequities between miner compensation and mine company revenues, and the significant depreciation of the South African Rand against the U.S. dollar and
most other major currencies are exacerbating precarious miner/mining company relations. Further complicating this working relationship are jockeying labor unions which compete with each other for membership and political clout. Oftentimes the competition between labor unions can intensify an already unstable situation.
Chart 2 below depicts the Rand's 39% slide against the U.S. dollar since its recent peaks in 2011. A similar, if slightly less dramatic, trend has been in place over the same time frame with the Rand falling significantly against the euro, British pound, Aussie dollar, and Canadian dollar. The underperformance of the Rand exaggerates the cost of South African imports and correspondingly hurts their consumers. It is generally the lower income consumers that truly feel the pinch of a falling currency.
Chart 2. Data Source: "ZAR/USD"; NetDania; accessed February 12, 2014.
The fractious nature of the miner/mining company relationships is highlighted by the events in August 2012 at Lonmin's (OTCPK:LNMIY) Marikana platinum mine. Following strikes involving demands for wage increases and similar concessions, the situation reached a boiling point with police killing 34 striking miners, representing one of the worst instances of violence South Africa has seen since the end of Apartheid. Prior to the strike in August 2012, platinum languished between $1,375 and $1,425 per ounce in June and July of 2012. As news of the strikes broke, platinum proceeded to rise over 20% between August and early October of 2012, peaking at $1,725. Chart 3 below highlights this move.
Chart 3. Data Source: "Platinum, Daily"; NetDania; accessed February 12, 2014.
Today we find ourselves in a similar situation as the Association of Mineworkers and Construction Union (AMCU) has initiated a strike involving more than 70,000 miners at Anglo American Platinum (OTCPK:AGPPY), Impala Platinum (OTCQX:IMPUY), and Lonmin Plc. An article published by Reuters indicates that this strike affects around 40% of the global output of platinum. The Wall Street Journal reports that the strike has cost the associated mining companies approximately $18 million per day since January 23, 2014.
There remains a significant disconnect between the demands being made by the AMCU and the concessions currently counter-offered by the mining companies. Negotiations broke down as mining companies rejected a proposal from South Africa's Commission for Conciliation, Mediation and Arbitration (CCMA) to more than double miners' compensation to 12,500 rand (approximately $1,130) over the next three years. On the flip side, mining companies offered to provide pay increases of up to 9% per year. This counter-offer was dismissed by the AMCU and negotiations have failed to progress from there. Discussions continue, however the substantial distance between the opposing parties' offers portends an extended negotiation process.
Interestingly, platinum did not respond positively to initial news of the strikes and actually fell in the aftermath. Chart 4 provides platinum's performance since the strike was announced on January 23, 2014.
Chart 4. Data Source: "Platinum, Daily"; NetDania; accessed February 12, 2014.
Platinum has since popped to about $1,425 but has failed to make any substantive moves higher, despite the ongoing disagreements between the AMCU and mine operators.
While the current strikes have not turned as bloody as the massacre at the Marikana mine in 2012, they have not been without casualties. An AMCU official died last week when police dispersed a crowd of striking miners using stun grenades and rubber bullets. Further complicating the matter is the rivalry between AMCU and the National Union of Mineworkers (NUM) which have been vying for members. NUM members are not currently on strike and oftentimes face intimidation and assaults by striking AMCU members as they try to go to work.
Political affiliations can also muddy the waters as the NUM has long been an ally of South Africa's governing party, the African National Council (ANC). While the AMCU doesn't seem to have any clearly delineated political affiliations, the "enemy of my enemy …" mentality seems applicable and future political posturing by the AMCU is plausible. With union agendas bleeding into the political arena, mining operations will continue to be pulled into a bipartisan quagmire as competing unions and political parties draw battle lines across South Africa's platinum belt.
In early 2008, the platinum price spiked to over $2,100 an ounce after the South African, state-run electricity supplier Eskom commenced rolling blackouts. CNN Money quoted Eskom saying that "demand for electricity may exceed the available supply from time to time." A casual reference to a severe inconvenience as the blackouts created a significant drag on the South African economy, which was already struggling under an employment rate of 25% (a level it remains close to today).
The prospect of intermittently available power prompted South African mine operators like AngloGold Ashanti (NYSE:AU) to announce halts in production. Five days following the decision to halt operations, mine representatives and Eskom reached an agreement where the mines were promised a consistent supply of power, but with their consumption limited to 90% of the normal amount. The quick resolution - respective to the proportion of the situation at least - emphasizes the tremendous clout the mining industry has within South Africa.
Chart 5 below provides the platinum price between 2000 and 2014; the grey line represents the parabolic spike starting in January 2008, propelling platinum to its record high. Prices hovered near these highs for a few months as the situation remained uncertain until platinum fell along with most assets in the latter half of 2008.
Chart 5. Data Source: "Platinum, Weekly"; NetDania; accessed February 13, 2014.
Ironically, South Africa didn't always have power supply issues. In the 1970s and 1980s South Africa had made significant investment into its utility infrastructure, going on what The Economist describes as a "power-station building binge …" The country's substantial coal reserves afforded South Africa widely available and cheap electricity - some of the lowest cost energy in the world. However, improvements to the nation's infrastructure slowed following the 1980s and subsequent bureaucratic wrangling delayed the necessary updates to avoid future supply deficiencies as the South African economy boomed with the rest of the emerging markets.
In the summer of 2013, Eskom cited anticipated delays to improvements to one of its plants, blaming contractors' "underperformance" and rising costs due to disruptions in labor. The cost of this particular plant's updates had increased by 15%, representing $10.3 billion of a broader $50 billion revamp of Eskom's productive capacities in an effort to avoid another 2008-style situation. However, missed deadlines and ballooning expenses - not to mention the ever-present risk of strikes and similar labor tensions - pose a significant threat to South Africa's power situation.
South Africa's continuing labor tensions and tenuous power supply will remain particularly important components of the platinum marketplace to monitor going forward. With 70% of the annual platinum production exposed to these omnipresent risks, supply disruptions are a viable catalyst for another spike in the metal's price.
SUPPLY AND DEMAND CONSIDERATIONS
According to Johnson Matthey, the platinum supply deficit in 2012 was 340,000 ounces and the 2013 deficit is forecasted to be 605,000 ounces (this represents 10.5% of the 5.74 million ounce supply projected for 2013). Chart 6 provides a breakdown of platinum demand between 2009 and 2013.
Chart 6. Data Source: "Platinum 2013 Interim Review"; Gross Demand for Platinum 2009-2013; Johnson Matthey; accessed February 5, 2014.
As provided in Chart 6, the bulk of platinum's annual demand is industrial. The majority of that industrial demand can be further broken down into demand for platinum used in autocatalysts, which clean vehicle emissions. Platinum is a primary component of the autocatalysts used in diesel engines while palladium is more heavily used in gasoline engines.
The Johnson Matthey report linked above suggests that autocatalyst demand will fall by 2% as India and Europe - the primary diesel markets - experience weak economic growth.
Demand from the European heavy duty sector is expected to rise by as much as 50% as Euro VI emissions legislation is adopted, toughening the emissions standards for heavy duty trucks sold subsequent to 2014. Increasingly strict emissions standards across the world, especially in China as it battles with air pollution, are anticipated to bolster autocatalyst demand for both diesel and gasoline engines going forward.
In 2013, car sales in the U.S. reached 15.6 million, up 7.6% from 2012, and the first time the figure exceeded 15 million units since 2007. China's car and commercial vehicle sales increased year-on-year by 14% in 2013, reaching 22 million units.
However, countries such as Brazil and India experienced declines in 2013 auto sales. Uncertain global growth and cooling emerging market economies will continue to mitigate recovering car demand in the U.S. and steady growth in countries like China. Autocatalyst demand may go up and down as varying economic conditions around the world influence vehicle sales, however, Johnson Matthey forecasts that broader industrial demand will have risen by 11.5% in 2013.
While investment demand represents a minor component of broader platinum demand, it is a wild card that moves at the whim of the marketplace. Sentiment surrounding precious metals soured in 2013, as reflected in poor price performance, however interest remains and could grow as the aforementioned supply concerns reappear in mainstream media. This latent demand, particularly for platinum, is characterized in the release of a new rand-denominated platinum exchange traded fund (ETF). This ETF acquired 660,000 ounces of platinum between its inception in April and the end of September 2013. This figure, acquired over such a short span, represents 11.5% of total platinum production anticipated for 2013. Over 360,000 ounces of platinum were purchased by the fund within its first month of operation. Johnson Matthey predicts that global platinum investment will have reached 765,000 ounces in 2013 - a record high.
COST OF PRODUCTION
The per ounce cost of production, for any metal for that matter, can be derived through a number of metrics and take into account a wide range of variables. Besides variations in accounting methodologies, a mine's location, ore quality, cost of labor, etc. all influence the average cost to produce an ounce of platinum. As a result, the figure is different depending on the source. Further, these figures oftentimes just represent the cash cost of pulling metal out of the ground and don't incorporate capital expenditures associated with finding new resources and building out mine pipelines as existing mine output slows down.
However, the general consensus is that the average cost of production per ounce of platinum is somewhere between $1,400 and $1,600. Admittedly a broad range, the reality is that current prices are hovering below the lower end of this scale.
A Forbes article from 2012 quotes mine productions costs around $1,400 an ounce.
A Bloomberg article from 2013 cites Implats (a South African platinum mine) quoting its average cost to produce an ounce of platinum at 15,957 rand ($1,447 at today's rand exchange rate - which is at its lowest against the U.S. dollar since 2009). Many South African mines are currently operating at, or near, a loss despite the dramatic slide in the rand against the U.S. dollar. Any reversal in the rand's slide against the dollar will correspond in rising mine operating costs in South Africa.
The Financial Times quoted a report by Barclays Capital which estimated platinum's "cost floor" was at $1,700 - $1,800, meaning any high-cost producers (largely South African) were losing money below this price range.
While it remains a moving target, having an idea of the average cost of producing an ounce of platinum can be useful when deliberating an investment in the metal. The reality is that as the price dips below various miners' costs of production they can only continue operations for so long at a loss before they will halt production. The resulting stoppages squeeze supply, push prices higher, and make those higher-cost mines viable once again.
The reality is that ceasing production at a platinum mine and restarting it in the future is an expensive proposition, especially for those with deeper shafts which are prevalent in South Africa. As a result, oftentimes a mining company will operate a property at a loss for a time in the hopes of avoiding the need to stop production and restart when prices recover and operations become economical again. It is uncertain when, or if, mines will begin paring back production because of today's prices, but if platinum's slide lower continues into 2014 it will remain an ever-present possibility. The cost of production dynamic will remain another observable consideration when making the bullish argument for platinum.
For the reasons addressed, current platinum prices represent an attractive opportunity to participate in an arguably undervalued asset. Chart 7 below provides platinum's price performance between 2001 and today. As emphasized by the black line, the platinum price is currently hovering slightly above a price band that has been of technical importance since 2006.
Chart 7. Data Source: "Platinum, Weekly"; NetDania; accessed February 13, 2014.
When one takes into account the significant concentration of platinum production in South Africa, the global supply and demand fundamentals, and the high and rising average cost of production, platinum has a number of possible catalysts for future price gains. As the price hovers above this historic support level, any one of these factors coming to a head could precipitate an exaggerated move higher (just as platinum has experienced in the past). While it is possible for platinum to breach this support level and move lower, it seems unlikely. If one can agree with this statement, acquiring an asset at, or near, a historically important support level - which is also below the estimated per ounce cost of production - could represent a very opportune entry point.
If platinum can be resilient in the face of transient distaste for the broader precious metals space, and maintain its price above the emphasized support level in Chart 7 above, it seems likely that one or more of the bullish considerations could reemerge in the public's eye and trigger another rally in the platinum price.
While many opine the unproductive component of a precious metals investment (i.e. no interest or income), today's ultra low interest rate environment does not provide an abundance of attractive interest and/or income producing alternatives - without a commensurate degree of risk at least. Additionally, depending on your sentiments regarding the global "recovery" and the outlook for U.S. equities (currently hovering near record highs), the yields on conventional debt and equity instruments and the performance of the underlying instruments may not compensate one adequately for the associated risk.
With the Federal Reserve promising to hold interest rates low, the environment should remain favorable for non-interest bearing assets like platinum. As individuals deliberate taking profits on equity gains, platinum may be an attractive medium- to long-term parking lot for that cash, from a value standpoint, as we see how things shake out in the global marketplace.