With the introduction of new exchange traded funds (ETFs) for platinum and palladium in the U.S. at the start of this year, and a similar introduction in Europe more recently, a lot of attention has been turning to the Platinum Group Metal end of the precious metals complex. [PGMs: Platinum, palladium, ruthenium, rhodium, osmium and iridium.]
The large uptake in investor demand for the new ETFs took many by surprise, for what have been traditionally more industrious precious metals. While gold took many of the headlines as it broke all time highs during the year, platinum and palladium both set their own records. They were in fact often seen outperforming the yellow metal. This increased appetite for the metals as investment assets, and their strong performance over the past year or so now leads many to ask where they stand on the physical supply and demand side, and what potential is there for further price appreciation for the second half of 2010?
To assess both of these factors however, one first has to note some of the fundamental relationships these metals have on both the demand and supply side. The auto industry for example, represents the largest consumer for both platinum and palladium, accounting for almost half of the entire demand during 2009. Both metals are used primarily in auto catalysts, with palladium dominant in gasoline engines and platinum primarily used in diesel engines. Regionally, the majority of diesel driven cars are sold in Europe, while most gasoline driven cars are sold in China and other emerging economies.
In addition to auto catalyst demand, platinum sees a significant demand coming from the jewelry sector, and following Chinese platinum jewelry demand more than doubling in 2009, is now just as fundamental and important to platinum prices as the traditional auto industry demand. A new and upcoming factor on the demand side for both of the metals however, are the new ETFs created by the fund manager ETF Securities, which although the holdings represent only around 5% of estimated global demand this year, the amount of platinum and palladium that was bought by the two ETFs every trading day actually exceeded global mining production for the two metals.
The less established European ETFs have also seen a similar surge in demand come about for platinum and palladium. They now jointly raise the possibility that, at some stage, investor demand will in fact outstrip the physical. This would lead to a divergence away from the fundamental factors as is often the case in other, highly liquid commodities. On the supply side, South Africa represents the world’s largest individual producer of platinum, currently at around 80% of all global production. Russia is the world’s largest producer of palladium however, accounting for more than 50% of global production. South Africa comes in second for palladium production.
The physical aspect of Platinum and Palladium
The ‘Platinum and Palladium Survey 2010’ published by the independent precious metals consultancy GFMS last month, offers us some insight into where the physical balance currently stands for both platinum and palladium, and how this has been changing during the past year. According to GFMS, the gross platinum surplus in 2009 rose by almost 50% from 2009 levels, to the largest levels ever recorded by the group at 849 thousand ounces. This comes predominantly from a 14% fall in global demand for the metal. That's unsurprising given the level of the global recession during the year and subsequent fall in demand for cars.
That said, the group suggests the surplus was limited somewhat by a similar fall in global platinum production, which fell by 10% to around 800,000 ounces. They suggest that almost 60% of this fall was due to a decrease in the levels of jewelry scrap, while mining production in the year only decreased by approximately 2%. Looking forward for 2010, they suggest that auto catalyst and industrial demand are expected to increase in line with the global economic recovery. This, however, is likely to be partially offset by falling jewelry demand, particularly in China, thanks to the sharp gains in prices. With this, they forecast a modest 5% increase in global platinum demand. GFMS suggests caution as a recovery in global mine production is likely to keep the surplus at historically high levels.
Unlike platinum, GFMS believes palladium reached a near balance in 2009, with a gross deficit of just 12,000 ounces. Again, this was largely due to a fall in demand thanks to the global recession. Although the group does note that a 14% decline in auto sector demand was not as severe as the decline in auto sector demand for platinum.
This fall in demand outstripped global palladium supply, which only fell by around 259 ounces during the year. GFMS suggests that while mine production and jewelry scrap both recorded similar declines, the majority of the fall came from a decline in auto catalyst scrap. Considering the outlook for 2010, GFMS believes palladium will show a larger gross deficit than in 2009. They do note this still may not reach levels seen in recent years. GFMS suggests the metal should benefit particularly from a pickup in demand for auto catalysts, thanks to increasing car demand amid the global economic recovery. Similarly however, global supply is expected to pick up as the economy recovers, and they note gains across global mine production are likely to be eclipsed by a surge in auto catalyst scrap supply during the year.
Although one could be forgiven for assuming these physical fundamentals would translate directly to price action for the two metals, this is not the case, particularly with the large uptake in the new ETF’s. During 2009 for example, platinum and palladium both saw a massive rise in prices, up 57% and 118% respectively. That's even before the introduction of the U.S. and European funds (and despite falling demand thanks to the global economic recession).
The global economic recovery taking place this year will naturally bring about an increase in industrial demand across the Platinum Group Metals. As the failing auto industry picks up and in turn, demand for auto catalysts, platinum and palladium should rise as well. This has in fact already been the case in the early half of this year. Accordingly, prices for the two metals have continued to rise. However, it should be noted that in a large way, particularly in Europe, this demand has been artificially stimulated by car scrapage schemes. This undoubtedly had an artificial ‘knock on’ effect for platinum prices particularly (recall platinum used in diesel engines, which are primarily sold in Europe). Now these scrapage schemes have been removed, auto demand across Europe may falter somewhat, or at least grow to a lesser extent than the early half of the year.
In China however, demand for cars is expected to surge during the year, with Commerzbank estimating 17.2 million could be sold to the country in 2010. Again, this will naturally lead to an increase in auto catalysts for gasoline engines, and in doing so bring about a comparatively higher demand for palladium compared to platinum. This leads to the potential for further comparative outperformance for palladium versus platinum, mirroring the performance of 2009.
The other major factor likely to effect the price action of both platinum and palladium during the second half of the year is undoubtedly going to be the continued increase in investor demand thanks to the new exchange traded funds. With both the U.S. and European ETF’s seeing a much larger than expected uptake in demand initially, the move has already accounted for much of the price appreciation in the first half of the year. So far, demand from these funds has shown little signs of any significant slowdown. A simple view would suggest that their existence itself will increase investor appetite for the two metals, in essence bringing more buyers to the market and thus continue to support prices.
There are some risks here.
Firstly, there is a possibility that this early surge in demand has actually run into overbought territory, running the risk of selling across the metals as investors’ initial euphoric sentiment fizzles out. An additional risk coming from these ETFs: Due to the increase in demand for the metals as investment assets, with the inevitable increase in speculative and proprietary trades this brings about, there may in fact be a decoupling of prices away from the fundamental factors underpinning price action. As noted earlier, this has already been coming into effect for both platinum and palladium. With fundamentals generally looking more lackluster than the price would suggest, there is a fair chance that a price correction may come through in the second half of the year.
That said, the global economic recovery, increasing demand for cars and jewelry, are all keeping the outlook for the metals buoyant for the second half of 2010. There would appear to be a stronger fundamental position for palladium compared to platinum, at least as far as auto catalyst demand is concerned. The increased appetite for the PGM’s as investment assets is likely to keep some focus of these key precious metals going forward. Still, the large uptake in these new ETF’s undoubtedly leaves at least some risk to any price appreciation.
However, one thing is certain: Although record high gold prices may hit the headlines, and base metals may see the majority of news flow surrounding the potential for economic recovery, platinum and palladium look set to benefit from both sides heading into the second half of 2010. The potential benefits for a wise investor should not be overlooked.
By Karl Loomes
Disclosure: No positions