High Prices Cut Demand for Metals

Mike Norman, anchor, HardAssetsInvestor.com (Norman): Hi everybody, welcome to HardAssetsInvestor.com’s interview series. I’m Mike Norman, your host today. My guest is Miguel Perez-Santalla, vice president of sales for Heraeus Precious Metals Management; that’s a mouthful. Miguel, why don’t you tell us a little bit about your firm and what it is you guys do.

Miguel Perez-Santalla, vice president of sales, Heraeus Precious Metals Management (Perez-Santalla): Well, Heraeus Precious Metals is a company that was founded over 150 years ago by Dr. Bill Heraeus, and principally he was one of the original melters of platinum and helped to supply the jewelry industry. From there the company grew into many facets of industry and manufacturing for platinum group metals and other precious metals as well in the jewelry market. We now have grown to having 12,000 employees worldwide. We have offices all over the world, including China, North America, South America. At this time, Heraeus is constantly growing and looking how to further produce product in those precious metals markets. So we’re a consumer as well as a trading company.

Norman: All right, let’s talk a little bit about those markets. Everybody knows, it’s no secret, that they have been on a tremendous tear over the last five or six years like all commodity markets. Perhaps those markets, more than any other, have led the pack. Tell us what has been - in your opinion, because you’re on the industrial side of it, you deal with industrial companies - tell us what are some of the factors behind the price run-up?

Perez-Santalla: Well, the original factor, of course, was the new consumption coming out of Asia from China and India. That initial growth spurt sparked the market going. Originally it was copper that drove it, then gold, then all the other metals started rallying along with it.

Once the metals were rallying, then there was news of the financial collapse due to the subprime mortgages, which then drove the metals even higher. In the platinum group metals, though, that was more affected by the problems in South Africa with the supply issues that started in February, and that drove the price up to over $2,100/ounce. Right now, we’re starting to see a correction there, but fundamentally, what’s gone on now at these high levels is that the precious metals consumers have held back. Now that it’s starting to correct a little bit, we’re seeing some new fresh plans.

Norman: Is this a repeat of events that we’ve seen historically, where you get a spike in commodity prices? For example, have we seen anything like this before in real dollar terms? Is this another one of these events where these metals have languished for a long period of time, undervalued, they started to go up, now maybe overvalued, and will correct back down on a constant dollar basis where they’ve been for a long time?

Perez-Santalla: My personal opinion from what I see - I do believe that it will correct. Will it go down from the levels we saw pre-2005? No. That was way undervalued, and then it started to come up. We’re a little bit overvalued at the moment; there’s going to be an adjustment. For instance, in the gold market, gold is currently trading above $900/ounce. The greatest consumer of gold in the world is the jewelry industry. Now the jewelry industry has come to a basic standstill with the price over $900/ounce because the consumer does not want to buy, so they’ve had to replace gold with other alloys. For instance, let’s say a ring that would have been just pure 18 karat gold before, it may be a 12 or 10 karat gold ring plated with 18 karats so it looks the same, but in reality, you’re getting less precious metal in that gold ring.

Norman: Let’s talk platinum for a second. What would you peg currently as the cost of production?

Perez-Santalla: What I heard recently is the cost of production is somewhere around $800 an ounce. Of course, one thing you have to take into account when they say that $800 an ounce is that they’re building all their expenses into platinum and they’re not really considering the residual gains they have from other metal by-products that come with the platinum group metals - which are rhodium … which by the way is an $8,000 an ounce metal … ruthenium and iridium, which are both around $300 to $400 an ounce.

Norman: So we got to see some hip-hop stars with rhodium watches, I think.

Perez-Santalla: I don’t think so.

Norman: That’s even out of their league, huh?

Perez-Santalla: Well, the interesting thing is that the biggest consumer of platinum and rhodium is auto catalysts, and I’m sure you’re well aware of the fact that SUVs probably hold the most amount of precious metals out of all the cars out there. So the SUVs are getting whacked - not only are people not buying it, but there are people ripping off the exhaust systems and having it refined somewhere, removing the catalyst.

Norman: Miguel, you hear people say, well, the price is determined by supply and demand, yes. But isn't there another element of demand besides the physical demand that industry needs? We're talking about investment demand now. You mentioned that jewelry demand, when we were speaking about gold, has kind of gone flat because the price has gone up so much. However, investment demand is still growing. How much of a factor … I know it's much less than industrial demand but it's growing … and it's an important factor, right?

Perez-Santalla): Those factors have also been part of what's helped the metals grow in price so much. What happened early on in 2006 and 2007 is the exchange-traded funds came out, enabling smaller investors to buy physical metal without having to hold it - in essence, a way to hold the metal in paper form. That was a huge chunk of metal that was taken off the market, so that affected the supply-and-demand factor, and that is taken into account. Then later on came the platinum group metals - platinum and palladium - they also created ETFs, and that also drove the metal higher. So these are fundamental causes that did drive the metals higher, and the investor demand has been there.

But as of late, we have seen investor demand start to liquidate, I think, because over the last few weeks we keep bumping our heads on the ceiling and [investors are saying], jeez, there doesn't seem to be any more upside potential here. And with the consumers - which is the industry - not buying and consuming, there's nowhere else for the price to go, and that's why at this time I remain bearish overall for the metals in the short term, and I expect to see gold, for instance, come down into the low-800s.

Norman: Really? Let's characterize the different sort of players in here, because we have the speculators who can go long and short, maybe exerting a short-term influence on prices, but then we have these big institutions like pension funds and endowments; they are long-only passive investors. They're not the ones who are liquidating now, are they? Because they've decided they want a 3% or a 5% allocation, they put it on, they're going to hold it.

Perez-Santalla: No, you're absolutely right. The ones who are liquidating are the investment funds that are trading in and out of the market. Usually they're trading to show their quarterly gains, and as of this time, I think that they're liquidating because they're starting to have confidence back in the U.S. stock market, in the bonds, and they're looking at paper again and starting to go in there. As you've seen in the last couple days, we've seen some really positive movement in those markets.

Norman: In the past, every time there's been a spike in commodity prices, you've seen technological advancements which led to a greater degree of productivity and efficiency, so we actually use less [of the underlying commodities themselves]. Will this price-spike trigger the same sort of technological advancement?

Perez-Santalla: Actually, it definitely has triggered that. In our industry, that's called thrifting, when, let's say, they used an ounce of platinum to make something, and now they try to figure out what's the least amount they can use. So thrifting has also been a factor which has reduced the consumption of platinum, and that's why we've seen weakness in the platinum market.

And I'll tell you another thing: Mines are not too thrilled to see platinum way too high because they have the fear that someone will replace the metal eventually with something else if the science ever gets there. So for instance, back when platinum was at $800 an ounce, I had two researchers doing it; now at $2,000 an ounce, I'd have 10 looking for a replacement, because there's got to be a cheaper way. There have been reports recently of replacement of platinum in certain catalysts, not in great amounts; like, for instance, it was Mitsui Mining who is replacing platinum catalysts with silver in heavy machinery, because there it doesn't matter the size. Nisshinbo Manufacturing (NSHBF.PK) has found a way to replace platinum catalysts in fuel cell technology, and they're going to replace it with carbon. They are little things, but little by little, they bite at that supply-and-demand factor, so that affects it.

Norman: Like they said, the Stone Age didn't end because we ran out of stone: We found other things to do. All right, there you have it folks: a perspective on the precious metals markets, by certainly an expert. Thank you very much for coming here. Stay tuned to this Web site because we've got a lot of great interviews like that on a regular basis. I'm Mike Norman, signing off for now. We'll see you next time. Take care.

Comments

[lark:]

High prices, because inflation. What causes inflation the FED printing machine, it is easy to print money. It is not easy to find gold or precious metals furthermore everytime is more difficult to find good mines. Profitable ones.

2008 Aug 27 01:38 PM

[Chuck Kasparov:]

Mike, thanks for the interview. Usually one would expect an industry insider to have a bullish bias on precious metal prices. So if he's expecting them to go down short term - that's a very strong signal. Also, very enlightening comments on what really affects the prices and supply/demand issues. Thanks again!

2008 Aug 27 11:03 PM

[Philman:]

I am interested in learning whether platinum has any significant investment demand. I know it is the rarest major precious metal, and it seems to be a lot cheaper now. Is it a buy? Or, will it go down to $800 per ounce, because people don't need it so much for auto catalyst use anymore, given what appears to be an oncoming recession/depression. Also, isn't China still selling tons more cars? And, Ukraine? And, so forth for all the second world? So, why is platinum going down so much? Is the supply problem in S. Africa, maybe, solved?

2008 Aug 28 03:12 AM

[dtblount:]

The supply issue in South Africa (source of about 75% to 80% of world platinum production and upwards of 90% of reserves) is focused on the nation's electricity shortage. Eskom, the nationalized utility has not added capacity to keep up with demand for electricity. I've read analyst reports saying that there is no way to add capacity on a significant level in the next five years. When Eskom has to cut power (coined "load-shedding"), it can strongly affect the mining industry in ways ranging from outright closure of operations (gold and platinum mines closed for five days in Jan) or cutback in operations due to limited electricity.

While the mining giants such as Anglo and Implats are exploring their own power generation, an impending coal shortage (where S.Africa gets most of their energy) and high price of diesel fuel will not make this any more cost-effective. One company to watch is Sasol (SSL), which is one of the world's leaders in synfuel development. With rising inflation and a slowing economy, S.Africa must salvage their mining industry to stay afloat while the rest of the world slows...which could lead to some new energy-related infrastructure investments between Eskom, Sasol, and the S.African gov't...

It's an interesting situation, and one to watch in the coming months and years.


Cheers

2008 Aug 28 11:31 AM

[jetsby10:]

the guy had some good stuff to say. But he really totally ignored the monetary aspect of everything. People are looking to hedge against inflation. They could give a damn about jewelry.

2008 Aug 28 11:38 AM

[bkuszmar:]

I am sorry to say that Perez-Santalla has no idea what he is saying (Like most so called experts) when they talk of Jewelry as the primary user of gold or how important "Jewelry" sales are etc..
it is not the jewelry sales we think of here in the US or in European countries, Gold Jewelry in the East is considered more money than Jewelry and is bought as an investment. Jewelry sales in India are the equivilent to Gold Coin/bars sales in the US and Europe.

The use of the term jewelry sales is really misunderstood and misused.

Brian Kuszmar

2008 Aug 28 03:09 PM

[User 30121:]

Bkuszmar: You are spot on!

2008 Aug 28 04:55 PM

[Mark Anthony:]

This guy, Miguel Perez-Santalla, is a permabear in PGM metals and he is proven wrong in the past repeatedly. I don't know why does he has any credibility at all if he can not get the basic historical facts right.

He said South Africa's power supply "issues" started in February? It was January 25, 2008 when the whole mining industry of South Africa was forced to shut down for 5 days due to a force majure declaration of ESKOM, the national electricity company. It was a global headline news and this guy could not even get the date right? And I would not call it "issues" whe this is a clear crisis.

I will debunk his arguments one by one at a later time. But for now please read what I have written in the past to debunk all the false myths in the PGM market:

seekingalpha.com/autho...

The recent price fall is nothing but mere market volatility, inevitable consequence of too much investment money chasing too narrow a market. This will pass soon enough and we will see an even stronger rally in the PGM metals market.

Don't you notice that rhodium recovered from $3850 to $6200 in just 4 trade days? That's a 61% gain of a commodity in just 4 trade days. That's the kind of extreme volatility that we will be seeing a lot.

2008 Aug 30 08:28 PM