3 Reasons Why The Palladium Market Will Get Stronger

Summary

• Palladium is the most flexible PGM being used in catalytic converter technology.
• Consumers demand more palladium in jewelry due to its weight-to-hardness benefits over other metals.
• Researchers are finding more use for palladium in biomedical applications.

Why Palladium Prices Are Exploding

If you have been watching the palladium price recently, you may have noticed an interesting trend. The price of palladium has doubled since August 2018. Palladium is now $1493 at time of this writing. Here is a 3-month price chart in Palladium from Apmex.com.

Image Source: Apmex

If you are one of my subscribers, you already know the reasons why palladium is in a bull market. Our December podcast described the reasons why the price was about to get much higher.

So, why is palladium price increasing? Here are the main reasons.

Palladium Demand is Strong

Palladium's largest single use is in automotive catalytic converters. The metal helps clean the air. More and more regulations are being made to reduce the emission of gases from automobiles as more of them are put on the road. This increases the demand from auto manufacturers for the metal.

Image Source: World Platinum Investment Council

Further, the tremendous growth in auto production in emerging economies like China has also caused increase demand for palladium in auto production. Chinese automobile demand has increased since the 1990s. It only recently fell off for the very first time in 2018. That led to a huge amount of pent-up demand for the metal around the world.

Image Source: Bloomberg

During the recent bull automotive bull market that was occurring, palladium demand kept increasing to the point that the market began experiencing supply deficits. The following chart shows that the palladium market has been in supply deficit for a number of years.

Image Source: Citigroup

Palladium Price Backwardation

The supply deficit is so strong that it had reached an inflection point. Lease rates for near-term palladium contracts had risen above the longer-term contracts. In commodities contracts, this is known as backwardation.

When a commodity reaches backwardation, it means that buyers are willing to pay more for the contract now than they will in the future. Buyers do this to obtain the actual physical commodity from the delivery of the contract.

This does not happen when speculators are gambling on the price of a commodity, because there is more risk to holding a contract for a longer period of time. The higher speculative risk means that longer-dated futures contracts are almost always more expensive. The exception occurs when buyers are actually trying to acquire the metal.

China's Emission Standards

Even though China's demand for autos has slowed down, the palladium price remains strong. Here is why.

China's automotive emission standards have gotten more stringent. The chart below from the World Platinum Investment Council shows the standards development since the 1990s. China is now on version 6 of their standards. Each change in standard has called for more stringent emissions. This has had the effect of increasing demand for platinum group metals. Several platinum group metals (aka PGMs) are used in catalytic converters. The PGMs include platinum, palladium, rhodium, ruthenium, iridium, and osmium.

Image Source: World Platinum Investment Council

The amount of platinum group metal usage is depicted in the average loadings used per vehicle. The loadings have been increasing steadily during the same time frame in which China has been improving their emission standards. Therefore, it is not just the number of vehicles that are being sold in China, it is the combination of sales growth and the increase in amount of PGMs that are used in each vehicle.

Image Source: World Platinum Investment Council

The amount of PGM loadings per vehicle is expected to increase so much with the new 6a and 6b standards that China will approach the current level of Japanese and US standards. Despite the slowdown in the Chinese auto market, the increase in PGM loadings should continue to increase the demand for palladium on the market. This will support the price for the intermediate term, even if we enter an official recession.

Diversity is Palladium's Strength

I fully expect the current price ranges of palladium to hold for some time. Even with the recent slowdown in the automotive market, the prices of palladium continue to rise. The pent-up demand for palladium leading to current palladium deficit will not be reversed quickly. The fact is that palladium is required for catalytic conversions on most passenger vehicles. Further, palladium is the most versatile of the 3 PGMs for use in the converters.

Image Source: National Center for Biotechnology Information

Platinum is denser than palladium, which makes it especially valuable for use in diesel engines. The popularity of diesel engines in the European market supported the platinum price. It is one of the main reasons why the metal was historically more expensive than gold. The other is that both palladium and platinum are rarer than gold, and therefore, more expensive to produce.

Recently, however, countries are beginning to ban vehicles that are considered more detrimental to air quality. This has reduced the European market demand for diesel vehicles, and therefore, also platinum. This is one of the main reasons why palladium's price has now risen past that of both platinum and gold. The other is that palladium is also rarer than platinum. Palladium possesses more flexibility for current regulation trends in the automotive catalytic converter market.

Palladium Rises to the Top

Years ago, it was common to dismiss palladium as the younger sibling of the most popular precious metals. Palladium, while being rare, was considered less valuable than platinum and gold. Gold has been money for 5000 years, while silver has been money for 6000 years. And both gold and silver are prominently used in jewelry and industrial applications.

Platinum was heavily used in industry as well. It is denser than palladium, and therefore, was seen as more valuable than palladium for use in jewelry because it was stronger. Palladium also has a lower boiling point than platinum, and therefore, is harder to use in certain applications. Platinum had been widely used in industrial applications long before palladium was.

However, palladium has taken center stage over platinum in more than just catalytic conversions. Palladium, being less dense than platinum, requires less metal to make the same piece of jewelry. Also, some people prefer the lighter weight of the palladium jewelry piece over the heavier platinum.

Palladium Gaining Popularity in Jewelry and Medicine

Palladium is also a harder metal than platinum and will wear better over time. This makes it attractive to jewelry wearers that are harder on their pieces. Alloys of palladium and gold form the increasingly popular "white gold" prevalent in jewelry stores today. Both palladium and the white gold alloys are as bright as silver and much harder and more rugged.

Further, palladium is just as useful in medicine as platinum. It can be used just as easily as platinum for medical implants and in dental implements. Palladium is used for crowns, bridges, and also as a coating for titanium to protect the surface of the base metal.

Platinum has been used in biomedical devices for 40 years. However, palladium has just started being introduced in biomedical applications. Palladium will be used more alongside platinum in this sector as the demand for medical care increases. The reality is that both platinum and palladium will be more in demand over time as emerging economies increase their demand for better healthcare and dentistry, in addition to automobiles.

Will Platinum Make a Comeback?

It has been discussed by industry analysts whether the price of palladium will cause the market to substitute the now cheaper platinum for palladium. After all, they have very similar properties and uses in industry and as jewelry. I had said in December that I believed the strong bull market in palladium would cause automotive manufacturers to switch to platinum. This would cause the price of platinum to increase.

With the recent regulation changes on use of diesel engines, however, I now think that palladium will be chosen more for typical gasoline vehicles than platinum. Palladium is easier to use in these applications, and only a few grams are used in any given vehicle. There is an elasticity of price in vehicles that will allow manufacturers to charge a bit more for their products due to price inputs, such as the increasing cost of palladium.

The breaking point for consumers on auto purchases is much more likely to be influenced by the financing costs due to higher interest rates than for the price of a few grams of palladium used in the catalytic converter. In other words, I worry more that a recession will affect vehicle demand than will the price of the PGM inputs into the manufacturing process.

This is a main reason why palladium prices have been allowed to balloon so high without a strong increase in platinum demand. The market is telling us that not only is palladium more rare than platinum, but it is also just as useful across several different industries, including jewelry.

Platinum will make a comeback in the market, but not necessarily as a replacement for palladium. The demand for both metals will continue to rise as the emerging market demand for their uses grows. No longer is the US the primary driver for economic activity in the world. The rise of China's middle class has changed the price base for nearly all commodities in the market, and will continue to do so in the long term.

PGM Industrial Substitutes - Are They a Threat?

We really cannot have a discussion around palladium and platinum markets without discussing substitutes. Staring with jewelry, the obvious substitutes are gold and silver. Silver and gold are softer, but have been used in jewelry since the beginning. I fully expect that at some point silver will make a comeback in the jewelry sector.

I believe this because the demand for gold, palladium, and platinum is increasing. And silver is more abundant and cheaper by far than the other three. If gold, platinum, and palladium continue their upward price trends, then consumers will substitute silver pieces. But I do not think that silver substitution will be strong enough to drive significant demand away from the other metals.

As for automotive catalytic converters, there is currently research ongoing into using base metal as substitutes. In an article published at the National Center for Biotechnology Information (linked to above), researchers note that:

In many important processes powered by a homogeneous catalyst, the cost of the catalyst’s metal component is a small part of the overall expense. Nonetheless, chemists are developing novel reaction schemes that use homogeneous catalysts made with “cheap metals,” said Morris Bullock, Laboratory Fellow and Director of the Center for Molecular Electrocatalysis at the Pacific Northwest National Laboratory (PNNL). These efforts are centered on using abundant, inexpensive metals - mostly first-row metals, but also molybdenum and tungsten - to replace precious metals.

This research is in the early phases, and does not immediately threaten the use of precious metals for industrial purposes. For example, while cheaper base metals can be substitutes, the catalytic reaction is less dependable than when using precious metals. Essentially, researchers have to re-engineer the existing processes using new base metal substitutes.

“The overall point I want to make is that if you’re trying to develop a new type of catalyst with a different metal, it is going to look a lot different,” said Bullock. “You don’t want to replace platinum or palladium with iron or copper and try to use the same ligand set. The ligands will almost certainly change.” The idea, he explained, is to not try to emulate what precious metals are doing as catalysts. Instead, the intention is to look at the reactivity characteristics of the cheap metals, understand the electronics of the reactions and the energy states, and then build a catalyst around those metals from the ground up using fundamental principles.

It will take significant time for researchers to develop the chemical agents needed to perfect the use of base metals for these purposes. That means the demand for precious metals in industry should continue to be strong for the foreseeable future.

Summary

Palladium market demand factors will get stronger over time for these reasons. First, it is the most flexible PGM being used in catalytic converter technology. Second, consumers demand more palladium in jewelry due to its weight-to-hardness benefits over other metals. Third, researchers are finding more use for palladium in biomedical applications.

A worldwide recession should put a dent in the meteoric rise of palladium prices when it eventually occurs. However, a rising tide of demand for PGMs in jewelry and industry should put a floor under their price moving forward. Until ready substitutes are developed using base metals, I don't see a huge crash coming to any of the PGMs used in industry.

Temporary price dislocations may occur due to widespread economic contraction, however. Investors should gauge recession risk before taking a strong position in palladium or platinum. Long term, the market for both are bullish.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.