Buy The Dip In Palladium

Aug. 5.14 | About: ETFS Physical (PALL)

Summary

Time to buy the dip in palladium.

Fundamentals are unchanged from a month ago. Both palladium and (to a lesser extent) platinum are in short supply due to South African strikes.

Russian sanctions could also prove disruptive.

Vehicle sales remain robust in major world markets.

Palladium has moved down several days in a row, giving a buying opportunity.

A temporary buying opportunity is developing in the palladium (NYSEARCA:PALL) ETF. It's gone down three days in a row on profit taking, sending it lower by 1.8% over the last week. Traders may want to buy the dip as soon as the corrective action is over.

Demand is up this year for both palladium and platinum with the recovery in the European auto market and the expansion in the U.S. and Chinese auto markets. US auto sales were reported to be up by 9% y-o-y in July. Both platinum group metals are used in automotive catalysts. Platinum is used in diesels, but palladium is preferred in gasoline vehicles due to its lower cost compared to platinum. Autos account for 38% of platinum usage, but 68% of palladium.

A strike in South Africa in the first half of the year reduced stockpiles for both metals substantially, palladium even more than platinum. As a result, palladium has been outperforming platinum and closing the price spread between the two metals.

The miners' strike is now over, but supplies remain tight, and will for months yet. South Africa was hit by another (electrician) strike that could also affect production soon after the miners' strike ended. The South African labor market is responding to inflation there, so there may be yet more strikes if wages do not keep pace with the cost of living. It's not clear exactly when production will get back to normal. In addition, Russia is actually the primary supplier for palladium, and the Ukrainian situation threatens to disrupt that supply chain as well. So far it has not, but it would be assuming too much to say that these critical metals were safe from political and economic disruption.

It should be noted that palladium is typically mined below cost. Both the platinum group metals are often found together, and the mine is operated in order to extract the platinum, with the palladium being merely a supplementary income stream that would not stand on its own. But the price of platinum itself was greatly squeezed by the shrinkage of the auto industry, Europe especially, where they have a stronger preference for diesels. Platinum was actually trading below the price of gold at one point. It has recovered to some extent and now trades above gold, but it does not yet enjoy the generous premium it did before the recession. This tight squeeze on the prices of platinum and palladium has to be considered the underlying cause of the miners' strike, since the mining companies could not pay their workers enough to keep up with South African inflation.

Both metals respond to changes in the price of gold as well, platinum more than palladium. Gold is also trading just above the cost of the gold miners to produce it. Even so, it has kept pace with stocks this year so far, exceeding the total return of the S&P500. I expect to see a continuation of inflation in the second half of this year, and a reluctance on the part of the Fed to keep real interest rates positive even when they do eventually raise nominal rates. That makes me bullish on gold, and also the platinum group metals. Also, while the tightening of the Fed may cause the bloom to come off the US auto industry, it will probably be cautious enough to prevent it from falling too far into recession. And of course, the Chinese and European auto industries will be unaffected by Fed rate hikes.

Conclusion: supply overhangs are gone in palladium, and greatly diminished in platinum. Palladium has been strong all year and looks particularly attractive to buy on the current dip. (NYSEARCA:GLD) and (NYSEARCA:PPLT) can also be expected to rise in the second half of 2014.

Disclosure: The author is long PALL. The author also is long physical gold. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.