Precious Metals: Some Recent Developments

by: Mark Anthony

I am convinced that the bullish fundamentals of palladium are even better in 2009. Recently, Impala Platinum (OTCQX:IMPUY) updated its estimate of platinum and palladium supply/demand data for 2008. Did you notice the significant drop in the Russian supply? The annual sale of Russian Strategic palladium stockpiles, about 1.5M to 2M ounces a year, finally ENDED! Back on June 11, 08, the palladium market had a knee-jerk response when Norilsk Nickel (OTCPK:NILSY) merely suggested the termination of the stockpiled palladium sale. Now that it really is ENDING, how will people react when it becomes widely known? Russia maintains a Defense Strategic Stockpile for its own wartime needs, not for selling PGM metals below cost to the world.

In Impala's estimates, recycling accounts for 1.1M ounces of palladium supply in 2008. The CPM Group estimated the recycling to be as high as 1.6M ounces a year. The good news is this supply will also be removed in 2009. A new catalytic converter contains about four grams of palladium, while an old one has about two grams left. Recycling recovers about 75%, or 1.5 grams each, worth about $9 in palladium at today's price. The PGM recycling process is a long, complicated and costly one, and at today's low price, there is simply no incentive for recycling. Stillwater Mining (SWC) is better off dropping the PGM recycling business and concentrating on mining. This could also boost the metal's market price, as it would free-up large working capital that was locked up in the recycling materials inventory, and enhance the company's balance sheet, as a result.

Upon recycling, more than 1M ounces of palladium supply are removed. Mining production also dropped significantly. Norilsk Nickel estimated that the 2009 palladium production would drop to 2.6M ounces from 3.0M as it now mines the nickel rich and palladium poor minerals to reduce cost. It also processes third party nickel concentrates, which contain no palladium. North America Palladium (PAL) shut the mine down earlier, thereby removing another 0.280M ounces supply, South Africa also saw about 10% drop of palladium production, or 0.25M ounces, and Stillwater Mining expects reduced production in 2009, as well.

When you add up all the supply disruptions and the halting of the Russian stockpile sale, despite of a 5.3% drop in auto catalyst demand, we are looking at an unprecedented palladium deficit in 2009. This is far greater than in any other precious metal, and we haven't even added in potential investor demands! Who wouldn't want to buy some palladium if you know what's going on!

The collapse of PGM prices in recent months was NOT due to fundamentals; rather it was due to investment funds as well as big automakers, especially General Motors (NYSE:GM) were forced to liquidate their precious metals holdings in order to raise cash. Automakers normally keep six months of PGM metals supply to weather any supply shocks, and when GM struggled for its survival, it had to sell its PGM inventory at a cheap price. Now that GM says, it can expect to survive without more government money, and in light of the looming shortage, it's time for GM to rebuild its inventory.

Palladium has by far the strongest fundamentals and the best potential for an explosive rally, among all precious metals. I still believe that due to the huge above ground inventory of gold, and the current price above the intrinsic value of production cost, the yellow metal has little room to gain in real value. Gold is a liquid and stable currency, but has no investment value if you are looking for gains.

I like silver better than gold. Silver is mostly a by-product metal so the supply is price-inelastic. As a safe haven investment, silver is more appealing to Joe-Six-Packs as it is more affordable, while gold is more appealing to rich people due to its high density of value. Most people on the GoldIsMoney forum believe silver is more bullish.

However, none of the silver bugs even presented specific and quantitative data on silver supply and demand so I wanted to take a closer look. Photography usage of silver, which traditionally accounts for one-third of the demand, is now diminished as digital cameras replace analog ones, and sterling silverware like spoons and goblets, is less popular than in the past. Industrial demand saw some increase in recent years, but is uncertain as the global economy goes into recession.

The biggest uncertainty factor is silver jewelry. Silver jewelry is low-end, cheap jewelry, which consists of those cheap bling-blings that you pick up in a mall or a grocery store, when you happen to have a few extra dollars and you just like what you see. Therefore, in a sense, silver jewelry is a discretionary spending item and is vulnerable in a slowing economy.

High-end jewelry, which is made of gold, especially platinum and palladium, is different from silver. This type of jewelry is most likely purchased as a special gift rather than a casual purchase. No one would buy a silver earring or necklace as an engagement gift, for example, and your fiancé would expect a diamond ring made of platinum, palladium or white gold. People will not take their platinum wedding bands to pawnshops for cash, but they are perfectly happy to toss out old pieces of silver jewelry.

Unlike PGM recycling, which is complicated and costly, recycling from scrap silver jewelries is simple and inexpensive as the materials contain high concentration of silver. Silver recycling remained at near constant high level over the past years, regardless of silver price. The PGM metals are different as low PGM prices discourage recycling and reduce the supply.

I believe silver remains bullish due to investment demand, but due to uncertainties in industry demand, I recently reduced my silver mining stock holdings in Silver Standard Resources Inc. (NASDAQ:SSRI), Silver Standard Resources Inc. (PAAS) and Hecla Mining Co. (NYSE:HL), and concentrated more on palladium mining stocks, SWC and PAL. The continued strong rally in Baltic Dry Shipping Index (BDI) shows that I also made the right call on the shipping sector. So, I continue to hold large positions in shipping stocks, like Excel Maritime Carriers Ltd. (NYSE:EXM), Eagle Bulk Shipping Inc. (NASDAQ:EGLE), Genco Shipping & Trading Ltd. (NYSE:GNK), OceanFreight Inc. (NASDAQ:OCNF) and DryShips Inc. (NASDAQ:DRYS).

Full Disclosure: The Author is heavily invested in palladium mining stock SWC and shipping stocks EXM, EGLE, GNK, OCNF and DRYS. I also hold positions in PAL, USO and OMG.