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The new paradigm for palladium

|Includes:PAL, ETFS Physical Palladium Shares ETF (PALL), SWC

It is official: The Russian state stockpile has finally been depleted!

The depletion was entirely predictable and anticipated. See for instance
The case for palladium, blogs and SA.

Long term Pt and Pd prices

So why is this event a game-changer for palladium?

Well, let's take a look at supply and demand...
Global demand for auto-catalysts reached 5,450,000 oz in 2010 (up from 4,050,000 oz in 2009) out of which 1,350,000 oz was met by recycling giving a net demand for the automotive sector of a healthy 4,125,000 oz.
Major demand-growth in the all-important auto-catalyst sector is happening in the Chinese market due to the combined effect of the ever increasing car sales in China and the introduction of the China-4 emissions standard this year which will require higher loadings of palladium (and rhodium) in the catalytic converters henceforth.

Other (net) demand in 2010 includes the electrical sector (970,000 oz) - in no small part due to growing demand for high-quality multi-layer ceramic capacitors for portable electronics such as smart-phones, the chemical sector (395,000 oz),
palladium jewelery (540,000 oz) and other sectors which include the dental sector 
with a combined 665,000 oz demand. Finally, for 2010 the net investment demand
(mostly from ETFs backed by physical metal) came to a net 1,090,000 oz.

In total, the net demand for palladium in 2010 was 7,780,000 oz (242,000 kg).

On the supply side there are three main sources:

1) Palladium byproduct from platinum mining in South Africa. This source delivered 2,575,000 oz during 2010. It is important to note, that since the main economic product is platinum this source is quite inelastic to the price of palladium.
2) Palladium byproduct from nickel and copper production in Russia. Again, inelastic by nature, this source delivered an estimated 2,720,000 oz last year - marginally beating the South African supply.
3) Sales from the Soviet-era Russian state stockpile of palladium delivered an estimated 1,000,000 oz (31,100 kg) every year for the last decade - but this is now over!
Other minor sources of palladium (such as production in North America and Zimbabwe (!!)) brought a combined 995,000 oz to the market last year.

Total primary palladium production was therefore about 6,290,000 oz (or 7,290,000 oz if we include the Russian stockpile sales as “primary” supply). To put things in perspective 6,290,000 oz, is equivalent to 196,000 kg and corresponds to just 7.8% of the 2,520,000 kg of global primary gold production last year. Palladium is indeed a very rare metal!

For the year 2010, we thus conclude, that the global palladium market was in a fundamental deficit of 7,780,000 oz - 7,290,000 oz = 490,000 oz - and that the deficit would have been a staggering 1,490,000 oz without the Russian stockpile sales. This kind of deficit (22-25%) is what the market will be facing by next year! In percentage terms this is a larger deficit than that which drove rhodium over $9,000/ oz back in 2008.

Rhodium price

Palladium will not go to $9,000 just because rhodium did, but it is a realistic that it will approach price parity with platinum which currently trades at the $1,500 /oz level. Pricing above platinum seems unrealistic as platinum can be used instead of palladium in auto-catalysts if the price of palladium were to explode. By the way, rhodium (which serves a different purpose (DeNOX) in the three-way catalyst) cannot be substituted with anything in gasoline cars, which is why it could go so much higher in price than platinum in the face of a rhodium deficit.

One-year palladium price
Keep in mind that tightening of emissions regulations has so far been irreversible and that once the law is in effect the car makers have no choice, but to increase the metal loading of the catalyst if they want to keep selling cars in any given market. The ultimate form of inelastic demand!
So to summarize. Despite its nice run from under $200 /oz during the darkest days of the crunch in early 2009, palladium remains a bargain at $600 /oz under almost any scenario.

How to play palladium?

I prefer physical bars or coins in my own possession, but ETFs backed by physical such as PALL might be a better option for some investors. The risk-takers might prefer playing the futures or CFD markets. Finally there are a couple of pure-play mining companies SWC (in the USA) and PAL (in Canada) that investors might want to consider.

Disclosure: I am long PALL.

Additional disclosure: I own physical palladium.
Stocks: PALL, PAL, SWC