This was a piece I had written over the past month and sent out to clients on February 24th, 2014. I have long been interested in platinum and palladium, due to their unique capacity to serve both significant industrial purposes, and their long standing history as real stores of value. Most uniquely, platinum and palladium have extraordinary catalytic abilities, mainly used in automobile catalytic converters. Their similarities are expected, given that they are vertically adjacent on the periodic table in the 10th group, also known as the Nickel Family. The 6 platinum group metals, together with gold and silver, form what's known as the Noble Metals; all considered precious metals because of their rarity and unique resistance to oxidation. Unlike gold and silver however, platinum and palladium are far rarer, both in terms of sheer reserve numbers, and more importantly, the small handful of geographical regions with naturally occurring platinum and palladium. Both metals are becoming increasingly harder to mine, as evidenced by the steadily declining grades of the ore produced over the past 10 years. Much like gold and silver, platinum and palladium producers are being forced to chase more expensive, lower grade deposits in order to extract the metals. It's no surprise that for many producers, the current metal prices are simply not sufficiently profitable, forcing mine closures. On February 6th, 2014, the Globe and Mail quoted platinum major Lonmin (OTCPK:LNMIY) CEO Ben Magara as saying that "about 45% of South African platinum mines were losing money". The dataset below should give a sense for just how scarce platinum and palladium truly are:
Precious Metals Annual Production Overview
Pricing and Supply/Demand
Interestingly, there is little difference in the amounts of platinum and alladium produced per annum. This similarity notwithstanding, platinum has traditionally been priced at a multiple of palladium, likely due to the fact that platinum was initially the critical metal in catalytic converters. For years, it took double the quantum of palladium in order to produce the same level of catalytic converters that could be produced from platinum. In 1989, however, scientists at Ford came up with the "1 for 1 substitution", allowing for palladium to be used instead of its counterpart in catalytic converters. This new development seemingly coincided with a supply surge from the Russian palladium stockpile, which has been sold into the market since the collapse of the Soviet Union. That said, palladium has managed to largely replace platinum in autocatalysts. Although both metals are projected to be in net supply deficit for the coming years, the forecasts for palladium are more drastic. Despite the fact that slightly more palladium is produced per annum, the demand is such that its net deficit will be even greater than platinum's for the foreseeable future. Stillwater Mining (NYSE:SWC) believes that palladium will reach a supply deficit of 1,050,000 ounces by 2015 (980,000 for platinum), and that the deficit will increase to 3,230,000 by 2020 (2,860,000 for platinum). KPMG, in a report, agreed that palladium's demand will outstrip its supply at a faster pace than platinum.
The palladium price spike in 2000 is rumoured to have resulted from a Russian hint towards declining stockpile supply, and subsequently, major car manufacturers bought on the open market to secure their share. I dug up a 2002 Wall Street Journal article which seems to corroborate the story that the big automakers were frantically trying to secure their supply of palladium:
Ford (NYSE:F) discovered that they could lower costs and still meet federal emissions standards by using more palladium in each converter to replace platinum or rhodium… Even inside Ford, people didn't believe that palladium could be put to such good use… By the early 1990s, most of Ford's converters relied heavily on palladium. Usually, less than an ounce of the metal is required per vehicle. Other auto makers, including General Motors and Chrysler, were also discovering the value of palladium, particularly as new, tougher emissions rules came into effect… From 1992-1996, global auto-industry demand for the metal nearly quintupled… But in 1997 the Russian shocked the market by holding up palladium shipments… Alarm bells went off within the big auto makers…
Platinum and Palladium are in demand for a host of other purposes as well. Sprott, on its website, points out that, "For platinum, sectors utilizing the metal include petroleum refining, electrical, glass manufacturing, medical, biomedical and dental, and other manufacturing such as turbines. For palladium, demand comes from electronics (as resistors and capacitors in circuit boards), dental and chemical industries." Sprott seems to see the value in these metals and has established platinum and palladium bullion trusts. Platinum maintains an edge when it comes to jewelry demand, which is what seems to keep its demand not too far behind the leading demand for palladium. Consumers might still view platinum as an alternative to gold given their traditional pricing similarities. According to Johnson Matthey, in 2012, jewelry and investments combined demanded 935,000 ounces of palladium and 3,215,000 ounces of platinum.
Platinum and Palladium - Historical Pricing and Price Ratios
Catalytic converters are fundamentally instrumental in speeding up the transformation of harmful nitrogen oxides, toxic carbon monoxide, and unburned hydrocarbons into more manageable carbon dioxide, nitrogen, water and oxygen. Essentially, a catalytic converter is the car piece responsible for keeping automobile emissions environmentally safer. For its ability to convert these 3 substances, the gasoline catalytic converter is also known as the three-way catalyst. The catalytic converter itself only became a part of automobiles some 25 years after French engineer Eugene Houdry had begun inventing the technology, when the US Environmental Protection Agency implemented regulations. Initially, gasoline catalytic converters utilized platinum, but through technological advancements, palladium has become substitutable and is currently the metal of choice. Diesel fuel, on the other hand, is sulphur-compound rich due to the lower temperatures, meaning that platinum has traditionally been more stable in these situations. Gasoline engine exhaust is higher in temperature, causing natural desorption of the sulphides and thus a more productive environment for the use of palladium.
Interestingly, even diesel vehicles have become more sulphur-light, meaning that a mixture of palladium and platinum (as high as 50/50 ratio) in diesel catalytic converters is becoming increasingly plausible. According to North American Palladium's (NYSEMKT:PAL) presentation, diesel engines "currently use 30% palladium, with scope to increase to 50% due to advent of low sulphur diesel fuel". Furthermore, the combination of both metals seems to create a more thermally stable structure due to the effects of bimetallic particles forming. The result has been a growing demand for palladium in catalytic converters: nearly 7,000,000 ounces in 2013, up 73% from 4,050,000 ounces over 5 years. On the other hand, platinum has not felt the same rising demand, and is now mainly useful only in diesel catalytic converters. Although diesel catalytic converters use more PGMs than regular cars, they occupy less than 20% of the global vehicle market, and are predominantly found in places like Europe and India. As a vague rule of thumb, modern vehicles require, on average, approximately ~0.1oz of palladium per catalytic converter. 100,000,000 vehicles would require somewhere on the order of 10,000,000 ounces of palladium. Two months ago, the Wall St. Journal reported that IHS Automotive is forecasting global vehicle production to reach 100,000,000 by 2018, which would be a substantial increase from the 83,000,000 cars produced in 2013.
Platinum and Palladium - Global Supply vs Catalytic Converter Demand
The European Union has defined emission standards, which have evolved from Euro-1 in July of 1992 to the current Euro-5, which has been in effect since September of 2009. These emissions standards are relevant given that the EU produces 16-17,000,000 cars per year. Indeed, on February 18th, 2014, Bloomberg reported that "European car sales rose a fifth consecutive month in January as the start of an economic recovery in countries sharing the euro encouraged purchases". More importantly, however, is the fact that other countries such as China, Russia and India, have started to impose EU Emission Standards onto their own vehicles in an attempt to similarly manage emissions. These countries have played quick catch-up, but are still behind the most current EU standards. India is still at Euro-3, while Russia and China are imposing Euro-4, with both countries planning to upgrade to the current Euro-5 this year. A host of other countries, including Mexico, Taiwan, Singapore, Brazil, Chile, and Colombia, have plans to upgrade their emission requirements to conform to some level of the EU standards.
One of China's most prioritized issues is its widespread air pollution, which has become known as the "airpocalypse". This problem is so prevalent that the New York Times wrote, "Outdoor air pollution contributed to 1.2 million premature deaths in China in 2010, nearly 40% of the global total." The Huffington Post quoted Beijing mayor Wang Anshun as saying that "air pollution is the biggest problem concerning people's livelihoods in the capital and that it would be worth spending a trillion yuan to bring back the blue sky". Just months ago, in October 2013, China's Harbin airport and schools in the district were forced to close as a result of the dangerous particulate levels. As billionaire Ivanhoe (OTCPK:IVPAF) CEO Robert Friedland noted in a recent presentation: "I have a home in Beijing but I've been avoiding it in recent years because the air pollution has become absolutely diabolical". As it happens, Friedland's Ivanhoe is developing the large Platreef platinum deposit in South Africa, which has recently been reported to have attracted interest from China National Gold Group. Last week, China's Cabinet announced a $1.6 billion Air Pollution Fund, to assist and reward regions focused on cleaning the air. China has been frantically trying to catch up in regulating emissions. The polluted Chinese air can very easily spread to other places, as far as the US West Coast. CNN recently wrote that "because of pollution from China, the Los Angeles area and other US regions violate national ozone standards". According to NASA (see visual below), "air pollution from eastern China regularly spreads to South Korea and Japan and out over the Pacific Ocean." There is an urgent need to mitigate China's dangerous pollution levels, and this need is propelling China to think of solutions, including a recent investment into a Zimbabwe platinum asset together with Eurasian Natural Resources (OTC:EURNF), in addition to its investment into Wesizwe discussed below.
Chinese Pollution Visual
(Courtesy of NASA Earth Observatory)
In 2009, China for the first time, overtook the US in becoming the #1 car producer in the world. As McKinsey and Company reported in November 2012, "China's automotive sector grew at a compound average rate of 24% a year between 2005-2001". Despite this surge, World Bank data suggests that China still only has 58 motor vehicles per 1,000 people, while the US and Japan have nearly 14x and 10x that number, respectively. It's no surprise that the combination of China's growing economy and its focus on mitigating pollution could lead to a potential demand increase for platinum group metals, particularly palladium, for its autocatalytic converters. Nearby, Japan is at the world's forefront of car manufacturing, and has been amongst the top 3 car producing countries in the world for the past 50 years (think Toyota, Lexus, Nissan, Honda, Subaru, etc.). In 2012, Japan produced nearly 10,000,000 vehicles, or 12% of the global total. Potentially, China could take Japan's lead in making sure its cars are environmentally regulated, which would have the added benefit of making its cars similarly exportable worldwide.
South Africa has long been the #1 platinum producer in the world, most famous for its rich Merensky Reef Mines in the Bushveld Igneous Complex. Interestingly, in 2010, Chinese miner Jinchuan along with the China-Africa Development Fund, invested $200m into Wesizwe's platinum project in the Bushveld Complex. In return, the investor group acquired 45% interest in the project, and Jinchuan would get first dibs at all platinum group metals mined from the project. However, recurrent mining strikes and shrinking Rand value has led many to believe that the South African supply is shaky at best. The miners are unionized under the Association of Mineworkers and Construction Union (AMCU) and, since January 23rd, 70,000 South African platinum miners from the largest producers have been on strike. "The strike is the biggest to hit the platinum sector since the violent work stoppage in August 2012" according to the Wall Street Journal (January 23rd). Roger Baxter from the South African Chamber of Mines was quoted in the Financial Times as saying, "If the industry were to capitulate and concede these demands that AMCU is looking at, it would severely test the viability of a number of companies". AMCU represents employees at major miners in the region, including Lonmin , Anglo American Platinum (OTCPK:AGPPY), and Impala Platinum (OTCQX:IMPUY). Additionally, these mines can run exceedingly deep, meaning tougher and hotter working conditions and the need for additional energy to cool down the environment. This invokes further worry given the country's unsteady energy supply. Eskom is the state owned energy company, providing 95% of the energy used in SA. According to the Economist (November 2013), "The margin between electricity supply and peak demand has been perilously thin since 2008, when power cuts brought many mines to a standstill. So narrow has the gap now become that the chance of another spell of blackouts is worryingly high." Eskom was recently forced to ask its users to curb their energy consumption in order to avoid power shortages. The article continues, "the latest emergency is a reminder of how perilously unreliable South Africa's power supply has become." Bloomberg has reported this week, that two Chinese private equity groups were "considering buying South African platinum assets after their value was depressed by strikes", which comes as no surprise given China's increasing need for platinum group metals.
Russia is by far the world's largest palladium supplier, predominantly from its nickel giant Norilsk Nickel (OTCPK:NILSY). I say supplier, not producer, because some of Russia's palladium has tended to come from its state stockpiles which were built up during the Soviet Union years. These stockpiles are held by the Russian Ministry of Finance, and its details have been kept as a state secret. Having said that, the palladium supply from these stockpiles, which has traditionally hovered around the million ounce per annum mark, has taken a dive from 800,000 ounces in 2011 to 250,000 and 100,000 in 2012 and 2013 respectively. British multinational Johnson Matthey has reported that the "stockpiles have been dwindling and are now pretty much exhausted." In agreement with Johnson Matthey, a recent Norilsk Nickel corporate presentation noted that the state "stockpile is most likely nearing a conclusion" and there may be "no stockpile sales starting from 2014". Norilsk's palladium production is set to remain relatively steady, with its forecasts projecting approximately 1% production increases per annum over the next 5 years.
US and Canada
The 2008 Financial Crisis led to a decrease in automobile manufacturing. Prior to the Crisis, General Motors had had a long established agreement with Stillwater Mining , the only primary palladium producer in the US, in order to lock in its palladium supply. This agreement was broken when GM was staving off bankruptcy, but has since been reestablished due to the recent uptick in car production levels. The US is expected to increase its car production by 3%, to over 16,000,000 vehicles in 2013, according to Deutsche Bank. Stillwater is based in Montana, is publicly traded on the NYSE, and produces around 400,000 ounces of palladium and 120,000 ounces of platinum per year. In March of 2010, Stillwater published a palladium white paper, which probably still remains the most comprehensive introduction to palladium. Another primary palladium producer in North America is Canadian small-cap North American Palladium (PDL on TSE and PAL on NYSE), with its Lac des Iles operation in northern Ontario, which produces around 130,000 ounces of palladium per annum.
Fuel Cell Vehicles
I've seen quite a few sources touting the massive potential for hydrogen-fuelled vehicles. Supposedly, the platinum required would be some 10x what gasoline cars use. Waterloo University has said that "an average fuel cell car requires about 30 grams of pure platinum to produce enough power to make them run, and will last for around 150,000 kilometers." The key fact is that there would be a need to produce hydrogen on a large scale in order to power these cars. It would require capital-intensive chemical plants powered by coal, oil or natural gas, mixed with steam and oxygen in order to produce the large amounts of required hydrogen… along with carbon dioxide. There are a few major car manufacturers working on commercializing fuel cell vehicles, so only time will tell how realistically feasible the concept truly is.
While the world continues to produce more automobiles, the demand for platinum and palladium is growing to supply emission controlling autocalysts. This is compounded by the fact that newer vehicles in growing markets like China, Russia and India, are going to be required to adhere to increasingly stringent emissions standards. China, the world's largest car producer, is grappling with dangerously high pollution, while its citizens are becoming increasingly likely to purchase more cars per capita in the coming year. Russian stockpiles seem to be dwindling, with the remainder of its palladium coming from its Nickel giant, Norilsk. With the vast majority of platinum coming from deeper and more expensive mines, in places like strike-ridden, energy unstable South Africa, it seems that many experts believe it is foreseeable that demand will outstrip supply in the near future. The supply simply isn't as readily available as the demand to use and own these metals. The market for these 2 super rare metals has historically been volatile, but the variables at play indicate the potential for an interesting ride ahead.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: The author has relied upon companies' presentations, analyst estimates, assumptions, third party assessments, and the opinions expressed are the author's alone. Nothing herein should be construed as an offer to sell securities The author takes no responsibility for any errors and omissions contained herein and accepts no liability whatsoever for any loss arising from any use of, or reliance on, this article or its contents. The information in this article is not intended to be used as the basis of investment decisions, and should not be construed as advice designed to meet the particular investment needs of any investor. This material is for information purposes only.