Volkswagen And Platinum: The Last Leg Down?

| About: ETFS Physical (PPLT)


Platinum, palladium and rhodium are primarily used in auto catalysts.

All three metals are currently in deficit. Platinum has been hit by the Volkswagen scandal.

Long run, all three are bullish.

This article focuses on platinum and palladium economics. Part 2 will cover rhodium and investment vehicles.

There are quite a few excellent articles on platinum and associated metals on SA, so I won't bother to restate the basics. This article goes into valuation and supply/demand. I have no idea on timing and don't trust technical analysis for my investing time frame, so I won't go into those either.

There are a few key facts that platinum group metals share:

- They are found together in nature. Most tonnage comes from mines that produce the full spectrum of the group. In most of the large mines Platinum [Pt] is economically predominant, although as described below, Palladium [Pd] is coming closer. Rhodium [Rh] is a pure byproduct.

- All three were in the past considered partially monetary metals a la gold, but investment is now a small part (or negative part) of their demand. Today the metals are prized for their ability to catalyze chemical reactions. The overwhelming part of this demand comes from new cars and trucks.

- All three are in deficit. Pd is in substantial deficit. However, above ground stocks of them are unknown. There is much metal in jewelry that could be monetized at very high prices.

Most SA readers are quite familiar with the ups and down of precious metals over the past generation. For some long-term perspective, here are the charts of the three going back to 1972 (note the log scale).

Over a long-term horizon like this, inflation and the value of the fiat currency ($US) must be taken into account. Here is the same chart, but adjusted into 2017 dollars.

One thing that strikes me about this chart is the 25-year uptrend in Pd, even in deflated dollars. This is quite unusual in commodities, the most mean reverting of asset classes. It also looks like Rh is on the cheaper end of its history.

Supply and Demand, Platinum

There are several good sources of platinum group metals statistics. I have based my analysis on Johnson Matthey's (OTCPK:JMPLD) numbers. JM has a wide presence in the industry, including trading, inventoring and manufacturing. So my guess is that they see the whole picture and are fairly unbiased. Readers should know, however, that there are sell-side analysts who think the situation is more bullish than this. Of course they are in the business of selling, though some of them have good track records.

Before I show the tables, there are two important points to make here. First, it is widely agreed that current Pt prices are far below those needed to bring new mines into production. This is a major longer term bull factor, although probably not too relevant for the next two years.

Second, there is potential for a big shift in the auto engine market that is wreaking havoc with Platinum:

Volkswagen and the Shift to Gasoline

Large and medium trucks use diesel engines. Most cars in the world use spark ignition. This is true in the fast-growing markets of China and India. Diesel catalytic converters require at least 75% Pt. Spark ignition cars can make due with almost all cheaper Pd. The exception is Europe, where about half the cars use diesel. Europe has been and will continue to enact stricter emission limits. More important, the EU is going to "real-world" testing of emissions, in response to the Volkswagen (OTCPK:VLKAF) cheating.

It will be somewhat harder to bring diesel up to the new standards. It can be done, as Mercedes has shown, but it is expensive. This likely means that there will be a shift from diesel to gasoline and from Pt to Pd. It might also mean a shift to Rh, which is particularly good at catalyzing NOX emissions (this is the big bugaboo in real world testing). The worry about this factor is probably the reason for the last leg down in Pt prices and in the Pt - gold spread.

I believe the diesel doomsayers are probably wrong. Europe has already built the infrastructure and refining capacity to use diesel. It will be more expensive to rebuild that for gasoline than to clean up diesel engines. Moreover, the spread between Pt and Pd prices has drastically narrowed in the past ten years from about $1000/oz. to less than $250. So the pressure for conversion is no longer there.

Here's the numbers for Pt. History is JM, 2017 and 2020 are my forecasts:

Supply 2014 2015 2016 2017 2020
South Africa 3,547 4,571 4,347 4,300 4,100
Russia 700 670 652 650 650
Rest of World 896 868 1008 1025 1050
Total Supply 5,143 6,109 6,007 5,975 5,800
Consumer Demand
Auto Catalysts 3,120 3,267 3,318 3,375 3,500
Jewelry 2,897 2,829 2,573 2,500 2,450
Industrial 1,776 1,749 1,964 2,000 2,125
Investment 277 451 487 450 450
Total Cons. Demand 8,070 8,296 8,331 8,325 8,525
Recycling -2,071 -1,730 -1,902 -1,950 -2,000
Total Net Demand 5,999 6,566 6,429 6,375 6,525
Stock Change -856 -457 -422 -400 -725

This assumes current prices. My view is that as time goes on, the low prices will slowly deplete mine production, while final demand continues to rise. This is obviously not a sustainable situation, which is why I am bullish on the metal.

Supply and Demand, Palladium

This one could be explosive. The large growth in spark ignition cars in Asia, along with the revival of the North American auto industry, has created an ever growing demand for Pd. Any shift in Europe to spark ignition would be icing on the cake. However, most Pd is a byproduct of Pt or nickel mining. Both Pt and Ni prices are depressed, and this is not helping Pd production. There are some primarily-Pd mines, and the S. African producers are concentrating on mines where Pd has a higher percentage, but this is at the margin. The market has been in substantial deficit for years. For a while this was offset by Russian stock sales, but this is mostly done. As mentioned before, no one knows what the above ground stocks of Pd are, but they are lower than before.

Here's the S/D table. Like before, history is from JM:

Supply 2014 2015 2016 2017 2020
South Africa 2,125 2,684 2,571 2,500 2,500
Russia 2,589 2,434 2,487 2,500 2,600
Rest of World 1,389 1,326 1,427 1,500 1,700
Total Supply 6,103 6,444 6,485 6,500 6,800
Consumer Demand
Auto Catalysts 7,500 7,655 7,840 7,960 8,275
Jewelry 272 225 215 200 150
Industrial 2,001 2,039 1,987 2,000 2,100
Investment 943 -659 -357 0 0
Total Cons. Demand 10,716 9,260 9,685 10,160 10,525
Recycling -2,752 -2,460 -2,549 -2,700 -3,000
Total Net Demand 7,964 6,800 7,136 7,460 7,525
Stock Change -1,861 -356 -651 -960 -725

The negative investment demand for Pd is not an error. It reflects the partial liquidation of the major Pd ETFs. Note that while this is selling into the market, it does not actually create any new Pd, just rearranges the owners. I am assuming that this will end with the recent bull market.

This is not a situation that can continue. Either Pd prices will have to rise much higher, or light vehicles will have to use less of it. I think it's reasonable to have the upside optionality.

Next Week: Rhodium economics and analysis of investment vehicles, (OTCQX:IMPUY), (NYSE:SWC), (OTCPK:ANGPY), Futures

Disclosure: I am/we are long IMPUY, PALLADIUM FUTURES.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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