Industrial Uses Driving Platinum And Palladium's Outperformance Over Monetized Gold And Silver

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Includes: GLD, PALL, PGM, SLV
by: Hard Assets Investor

By Amine Bouchentouf

Over the last few months, we've witnessed a distinct dichotomy in the intra-performance of the precious metals complex. Specifically, while gold and silver are amid one of the worst drawdowns of the last decade, platinum has essentially remained flat, while palladium is going through an uptrend not seen since 2012. Let's look at what may be some strategies in this market condition.

Over the last decade, and over the last five years specifically, gold and silver have experienced a trend that their cousins platinum and palladium haven't. I like to call this trend the "monetization effect" of precious metals. Essentially, what happened in the early part of the last decade was the monetization of gold, which then led to the monetization of silver. By "monetization" I mean that investors increasingly regarded gold first and then silver as monetary assets and not just precious metals.

This trend started years ago in the gold market and was exacerbated by an investment product that we now take for granted: gold ETFs. The advent of the first gold ETFs literally changed the game in precious metals. It facilitated access to the gold markets, which previously could only be accessed through complex derivatives strategies on the commodity exchanges or through the logistically burdensome physical bullion market. The ETF provided investors with speedy and easy access to the gold markets.

Gold Year-to-Date Performance (-16.79%)

A parallel trend also accompanied the advent of ETFs: More and more investors began regarding gold as an alternative paper currency. As more investors began to view gold as money, and as ETFs offered these investors an easy way to express their market views, a large segment of the gold market became dominated by financial investors as opposed to physical investors. This trend also spilled over to the silver markets as well through the development of silver ETFs.

Silver Year-to-Date Performance (-26.49%)

One of the advantages of the ETF is that it allows anyone at any time to buy or sell an underlying asset. In the gold market, this helped provide liquidity. But the drawback is that ETFs attract a lot of speculators and traders who are only looking to capitalize on short-term swing movements. They are not in it for the long haul. What we experienced earlier this year was some of the speculative activity leaving the gold markets; this was a painful episode (and there may be more), but it is a necessary self-adjusting mechanism to rid the market of all the excess speculative froth. The same happened in the silver market.

Physical Market

Unlike gold and silver, platinum and palladium have not experienced the "monetization" effect. This is in large part due to the nature of their use. Gold and silver are viewed by a large number of investors as an alternative to paper currencies, which is why people store them in vaults. Palladium, and to a lesser extent platinum, have both remained industrial metals with a large part of the market demand coming directly from commercial players (and not financial interests). The metals are used and not collecting dust in a vault.

Let's take platinum, for example. Platinum's primary application is its use as a primary material in catalytic converters, which is an essential component in the automotive industry. In fact, over half of all platinum mined finds itself in a vehicle for this important industrial application. Another third is used for jewelry, and only about 10% is actually held by investors as a store of value. This is very different market dynamic than the gold market, which has very little industrial uses.

Platinum Year-to-Date Performance (-5.08%)

Platinum YTD

Platinum experienced a drawdown this year, but not nearly as severe as the one experienced in the gold or silver markets. This market is physical and industrial, which is why platinum will outperform both gold and silver this year. The two main drivers will be supply disruptions caused by labor unrest in South Africa (the biggest producer) and increased activity in the automotive industry (the biggest consumer).

Palladium has in fact more industrial use than platinum, since more than 75% of palladium is used in the development of car-exhaust filters. Palladium is therefore slightly more immune to financial maneuverings than platinum, and much less than its silver and gold counterparts. The bottom line is that palladium and platinum are overwhelmingly industrial metals, and are therefore subject to market movements that are different than those in silver and gold.

Palladium Year-to-Date Performance (+6.94%)

Palladium YTD

The latter have been transformed by the advent of ETFs, and it is only normal that we see a sharp correction. In the long term, this is healthy for the market in order to rid itself of superfluous speculative activity.

Disclosure: The author is long gold.