The Bloodshed In South Africa Causes A Platinum Group Metals Panic

 |  Includes: LNMIY, PAL, PALL, PPLT, SWC
by: Mark Anthony

Do you notice that Stillwater Mining (NYSE:SWC) surged +7% on Thursday August 16, 2012? North American Palladium (NYSEMKT:PAL) followed and surged +9% on Friday. These two companies are the world's only primary PGM (Platinum Group Metals) producers outside South Africa. South Africa produces 80% of the world's platinum and 45% of palladium, according to Platinum Today.

Mining workers of Lonmin (OTCPK:LNMIY), the world's 3rd largest platinum producer, went on strike recently over salary dispute. The protest went bloody on Thursday, as South African police killed at least 34 striking miners and wounded 78 others. That caused platinum and palladium prices to surge and shares of SWC and PAL to rally.

I am a big fan of palladium since my second SA article. I argued that PGM metals, especially palladium, are price inelastic both in supply and in demand, and thus their prices could be driven much higher on every shortage. Rhodium price once went from $300/ounce to over $11000/ounce in 4 years, due to a small supply shortage of less than 4%. Read my article on rhodium and coal.

History shows how even a small supply disruption could cause a panic rally in PGM metals. In early 2008, South Africa was plunged into a nationwide electricity crisis due to a lack of coal and electricity capacity. PGM mines were forced to shut down for 5 days.

That was all it took to send platinum price from $1400/ounce to $2300/ounce in just one month. Palladium price went from $380/ounce to $585/ounce during the time. Shares of SWC went from $10.73 to $22.72 in just 21 trading days. Shares of PAL likewise doubled as it went from the low of $4.55 to $9.43 in just 11 trading days. Unfortunately the rally faded out as South Africa managed to stabilize its electric grid, and the weaker PGM demand from the auto sector prevailed.

Is the current riot and bloodshed in South Africa a replay of the 2008 PGM panic? Lonmin produces roughly 0.72M ounces of palladium per year, or roughly 10% of the global supply. If the disruption could be resolved quickly, there might not be a significant impact on global supply. But due to the severity of the bloodshed, I believe mining workers from other PGM mines might join force and go on strike in sympathy as well. After all, miners at other south African PGM companies are also paid poorly.

I believe you cannot go wrong loading up some shares of SWC and PAL and buy platinum and palladium coins at this moment.

I send my condolences to the South African PGM miners who lost their lives. They deserve better. Platinum and palladium, two critical strategic metals, deserve much higher prices that reflect their real costs. I think it is ridiculous that platinum and palladium, being 15 times more rare than gold (NYSEARCA:GLD), should be priced so much cheaper than gold as they are now.

Few people see the connection between platinum, the white gold, and coal, the black gold. But I did. Mining and refining PGM metals is extremely energy intensive. It is estimated that it costs 10^10 Joules of energy to produce one troy ounce of PGM metals, just on the direct energy costs. About 15% of South Africa's electricity is consumed by the PGM mining sector.

Electricity is generated from coal. South Africa is a major coal exporter. ESKOM, the electric power company, cannot compete with foreign coal buyers and had to settle for cheap inferior coal for years. The problem is that the government regulated electricity price in South African is far below the fair cost of fuel to generate electricity. Moreover, the mining industry pays only 1/3 of the electricity price that average resident customers are paying.

In a sense, the South African government subsidizes its PGM mining industry by supplying coal to ESKOM at prices way below market, and then supplying electricity to its PGM mining industry at prices way below the fair cost of electricity generation. The PGM industry in turn pays its mining workers rip-off low salaries. Foreign buyers of the country's PGM exports benefit from way below cost PGM prices. The people of South Africa are the ones picking up the tabs.

This is unsustainable. ESKOM has to pay fair prices to complete against foreign coal buyers for coal supply. It has to charge all its customers fair prices for electricity that ensures a moderate profit. The PGM industry has to pay its workers fair salary and has to cut production to demand fair prices for the precious metals it produces. I believe now is a great time to invest in palladium, platinum, and the only two north America PGM producers, SWC and PAL. Investors can also buy physical metal backed ETF funds, ETFS Physical Platinum Shares (NYSEARCA:PPLT) and ETFS Physical Palladium Shares (NYSEARCA:PALL).

Disclosure: I am long SWC, PAL.