Platinum Vs. Palladium: A Key Factor Holding Back Platinum Demand And Price

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Includes: PALL, PPLT, SPPP
by: Geoffrey Caveney
Summary

Precious metals investors have been surprised and frustrated by the platinum price stubbornly lagging the palladium price for years now.

In theory and according to market logic of supply and demand, industrial demand should now shift to cheaper platinum, but that has not happened.

I analyze a key factor that may explain why automakers and other industrial users are hesitant to switch back to platinum, even at an apparently significant price discount:

There's significantly more diversity in the annual production of palladium by country and region of the world than there is in the production of platinum. The U.S. and Canada produce much more palladium than platinum.

Therefore, in case of a significant temporary or prolonged supply disruption from South Africa in particular, or from Russia and Zimbabwe as well, automakers and other manufacturers in North America and the rest of the world could potentially have much more difficulty dealing with supply shortages in platinum than they would with palladium.

For almost two years now, myself and many other precious metals market analysts have watched in amazement as the palladium price (PALL) (SPPP) has soared higher than the platinum price (PPLT). Veteran commodity market analyst Andrew Hecht recently discussed the various issues holding back the platinum price and frustrating platinum investors in his article, "Platinum Is Not The Rich-Person's Gold."

Many analysts, including Hecht, myself and others, have repeatedly made the point that according to the market logic of supply and demand, it seems to make no sense that the platinum price could possibly lag as much as $500/ounce below the palladium price, as it has throughout 2019 to date:

(Source: stockcharts.com)

(Source: cnbc.com)

On the surface, this price discrepancy seems to fly in the face of market logic of supply and demand, since platinum is supposed to be a fully effective substitute for palladium in the metals' main industrial application, in automobile catalytic converters. In fact, platinum was the original metal used in all catalytic converters for decades, and only around the decade of the 2000s did automakers transition to palladium for most car engines (except diesel) precisely because at that time, palladium was many hundreds of dollars per ounce cheaper than platinum.

In theory and according to market logic and economic sense, now that the situation has reversed and it's platinum that's many hundreds of dollars per ounce cheaper than palladium, one would expect automakers to now go back to platinum again.

But as Hecht's article pointed out, that has not happened yet:

Platinum is denser than palladium and rhodium and can be a substitute for each metal when it comes to industrial applications. At over at $560 discount to palladium and an almost $2,000 discount to rhodium, the demand for platinum should be rising. However, it is not.

In this article, I will analyze a key factor that may potentially explain why automakers and other industrial users may be hesitant to switch back to platinum, even at an apparently substantial price discount:

There's significantly more diversity in the annual production of palladium by country and region of the world than there is in the production of platinum.

In particular, for North American automakers and other industrial manufacturers, the available sources of palladium supply from production in the U.S. and Canada are substantially greater than that of platinum.

Here's a table of the annual palladium and platinum mine production by country in 2017 and 2018, produced by the U.S. Geological Survey and available here:

(Source: U.S. Geological Survey, usgs.gov)

(Note: the numbers represent kilograms [kg]. 1 kg is 32.151 troy ounces.)

Let's take a closer look at the distribution and diversity, or lack thereof, in the production of palladium and platinum by country and region of the world:

Palladium production in 2018:

Russia: 85,000 kg

South Africa: 68,000 kg

Canada: 17,000 kg

U.S.: 14,000 kg

Zimbabwe: 12,000 kg

Other countries: 11,000 kg

Yes, Russia and South Africa produce the majority of the world's palladium, but at least Canada, the U.S., and other countries have a relatively substantial share, 20% of the world's production.

Thus, in case of a temporary supply disruption from either or both of Russia or South Africa, automakers and other manufacturers would at least still have access to a significant amount of palladium supply from North American or other global sources.

But with platinum production in 2018, it is a rather different story:

South Africa: 110,000 kg

Russia: 21,000 kg

Zimbabwe: 14,000 kg

Canada: 9,500 kg

U.S.: 4,100 kg

Other countries: 6,100 kg

In platinum, the single country of South Africa dominates the world's production of the supply. Russia and Zimbabwe produce a substantial portion of the rest of the world's platinum supply. Canada, the U.S., and all other countries only produce a mere 12% of the world's platinum supply.

Looking at the production gap another way, the U.S. produces more than three times as much palladium as it does platinum, and Canada and other countries produce almost twice as much palladium as they do platinum.

Therefore, in case of a significant temporary or prolonged supply disruption from South Africa in particular, or from Russia and Zimbabwe as well, automakers and other manufacturers in North America and the rest of the world could potentially have much more difficulty dealing with supply shortages in platinum, than they would with palladium.

This risk may very well be one key factor that explains why automakers and other industrial users may remain hesitant to switch back to platinum for catalytic converters and other applications, despite the apparently significant short-term cost benefit that they would seem to stand to gain by using platinum instead of palladium at this year's prices.

Ironically then, although a supply shortage is typically a very bullish factor that drives up the price of a commodity, in this case it may be that the threat of a future supply shortage is scaring industrial purchasers away from going back to a dependence on platinum, thus keeping present demand for platinum low, and depressing its current price.

Another factor here is that for automakers, switching from palladium to platinum or vice versa, is not a simple alternation that can be made in a day, a week, or even a month. It took years to adjust and re-design the automobile production process to enable the previous transition from platinum to palladium, and it would again take years to reverse the process. Cars have changed a lot in the past 20 years, and it's not like the automakers can just go back and dust off the old platinum-based catalytic converter designs and production process from the 1990s and expect it to work the same way in the 2020s.

Moreover, if they did make the switch now, then if they had to switch back to palladium again rive or 10 years down the road, they would have to go through the same re-design process all over again, since palladium-based catalytic converters in the 2030s will be likely to be very different from the current ones in the 2010s.

In many cases, the total cost of these redesign and transition processes could be substantial enough to negate the cost savings of using platinum instead of palladium at today's prices. Perhaps if automakers had confidence that platinum would remain significantly cheaper for the next 10 years or longer, and that it would not be at risk of future supply disruptions, then a one-time expense to re-design the production process could be worthwhile and economic.

But in fact the automakers are wise not to trust in a long-term cheaper platinum price, and to fear the risk of future supply disruptions. Ironically, this calculation appears to be keeping both the present demand and the current price of platinum lower for the time being in 2019.

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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.