Palladium: The Not-So-Precious Precious Metal

Mar.21.12 | About: ETFS Physical (PALL)

Although I own both platinum and palladium investments, I've been more bullish on palladium lately. And palladium has certainly performed well since it bottomed at around $200 per ounce during the financial crisis - performing better than platinum, in fact.

Click to enlarge

But palladium's riskier, because it's by far the more industrial of these two metals.

You probably know that both can be used as autocatalysts in catalytic converters, but they're not completely interchangeable - at least without redesigning your catalytic converter a bit. There was a time many years ago when platinum was the main autocatalyst of choice, but back in the 1990s, automakers began using palladium because it was a lot cheaper - back then anyway.

Forbes recently quoted William Tankard, senior mining analyst at Thomson Reuters GFMS, on his predictions for palladium based on its demand as an autocatalyst:

Platinum's use in autocatalysts remains 25% under the 2007 levels, Tankard said. Palladium also has begun to eat into platinum's market share in autocatalysts and that is helping stocks to grow in platinum. Right now palladium has 90% of the market share in gasoline engines and is rising in diesel engines, Tankard said.

Tankard is predicting that palladium could rise from $700 to $1,000 an ounce "in the coming years" with platinum prices remaining flat. But this also caught my eye:

The only caveats for palladium is any move to smaller engines and the outlook for electric vehicles. Those cars may not use PGMs (platinum group metals) in their construction.

That's actually kind of a big caveat. And it's worth noting, because if electrical power replaces gasoline and diesel engines, then palladium could be looking for another job. And it does not get unemployment benefits.

But my bet is that if electric vehicles do, umm, gain steam, traditional engines won't become obsolete overnight. Chinese demand, for example, should stay high for years to come.

Tight supplies: Relying on Russia and South Africa

From a supply standpoint, there's really not all that much palladium or platinum produced every year. Here's a look at the number of ounces supplied, by region since 1980 - from data compiled by Johnson-Matthey.

Consider that hundreds of millions of ounces of silver are supplied each year, compared to less than 10 million ounces each for platinum and palladium. Rarity alone does not guarantee a high price, but it does indicate a very tight market. A few hundred thousand ounces here and there can send these markets reeling up and down quite rapidly, especially since the vast majority of both metals come from only two places, Russia and South Africa.

On the palladium chart, you'll see a darker red area marked "Russia stock sales." This represents supply that Russia had stockpiled and began selling a few years ago. Most analysts believe that this stockpile has mostly been depleted (or even "exhausted," according to Tankard), which is one reason why the price has moved up so rapidly in recent years.

Demand: Investment vs. Industrial

Now let's look at world demand. These charts show the demand by application for both metals.

Note that the majority of palladium is now used as an autocatalyst, while most of the platinum supplied is not. Here's a chart that shows this more clearly in percentage terms.

Platinum, on the other hand, has a much bigger market for investment and jewelry, shown here in percentage terms.

In fact, platinum has been in high demand for jewelry in Asia as this Bloomberg article explains, especially in recent months when the price of an ounce of platinum was as much as $100 per ounce less than an ounce of gold (platinum is now trading roughly at parity than gold).

Platinum is viewed far more as a precious metal than palladium, so if you're going to invest in palladium, keep in mind that its industrial demand is far more essential to price performance than for platinum. It's kind of like the difference between gold and silver. Sure, all four metals are "precious," but some are more precious than others.

What keeps me bullish on palladium are trends that show ever increasing demand in emerging markets. These charts show demand for both metals by region.

You can see that for both metals, a much larger amount of production is going to satisfy demand in markets other than North America, Europe and Japan. This graph shows this trend a bit more clearly.

Buy the ETF or even the real thing.

I think that investing in palladium represents an excellent opportunity to take advantage of a strategic metal that has few substitutes. And one convenient way for investors to do so is to buy shares of the Physical Palladium Shares ETF (NYSEARCA:PALL). Each share represents roughly one-tenth of an ounce of the metal.

But I'd buy in stages, not all at once. For example, you would have regretted putting a whole bunch of money into palladium just before the Japanese earthquake and tsunami last year. Palladium fell 15% in just a few days. Platinum was down too, but not by nearly as much.

In a Barron's article last week, Simon Constable quoted a couple of commodity analysts who were bullish on the metal, with Rohit Savant at CPM Group predicting an average price of $772 per ounce in 2013, and Matthew Turner, a strategist at Mitsubishi Corp. International in London, who sees $1000 per ounce as "possible" in 2013 or 2014.

But as Simon pointed out:

Of course, all bets are off if the global economic recovery falters and demand for cars falls. Likewise, lack of supply constraints could take the luster off any rally.

He also suggested another way to buy palladium: Bullion-grade coins such as the Canadian Palladium Maple Leafs.

That's a good choice for a long-term holding, but these coins do sell for around $35 per ounce more than the spot price and I'm not sure you can buy them for a tax-deferred account. So I think the Physical Palladium ETF probably makes more sense for most investors.

Disclosure: I am long PALL, PPLT.