Palladium Weekly: Don't Fear The Recent Selloff

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About: ETFS Physical Palladium Shares ETF (PALL)
by: Orchid Research
Summary

PALL rebounds this week after experiencing last week its largest sell-off (-9%) since late March.

Spec positioning is light, suggesting plenty of room for additional speculative buying.

ETF outflows continue at a steady pace but are unlikely to have a material impact on palladium prices.

Despite weaker-than-expected auto sales and stronger-than-expected Russian palladium production in H1, the palladium market remains in a structural deficit, which should thereby underpin its long-term price appreciation.

PALL: As we expect buying on the dips sooner rather than later, we retain our target of $153 per share in August, which now implies a rally of 14% from here.

Introduction

Welcome to Orchid's Palladium Weekly report, in which we discuss palladium prices through the lenses of the Aberdeen Standard Physical Palladium Shares ETF (PALL).

PALL has rebounded well since the start of the week (+2%) after selling off sharply by 9% last week – the largest weekly loss since late March.

Last week’s sell-off was triggered by 1) a sharp rise in the dollar (caused by a lack of conviction from the Fed to ease significantly and sustainably its monetary policy stance) and 2) a sharp de-risking caused by a re-escalation of the US-China trade tensions.

However, we are not overly concerned about the recent selloff in palladium prices because it is not abnormal for PALL to experience large price swings.

Since the fundamental picture of the palladium market is tight, PALL should experience some buying on the dips sooner rather than later, in our view.

In this context, we view the recent selloff as a healthy technical correction, which should prove short-lived.

We retain our target of $153 per share for August, implying now a potential appreciation of 12% from here.

Source: Trading View, Orchid Research

About PALL

For investors seeking exposure to the fluctuations of palladium prices, PALL is an interesting investment vehicle because it seeks to track spot palladium prices by physically holding palladium bars, which are located in JPM vaults in London and Zurich. The vaults are inspected twice a year, including once randomly.

The Fund summary is as follows:

PALL seeks to reflect the performance of the price of physical palladium, less the Trust’s expenses.

Its expense ratio is 0.60%. In other words, a long position in PALL of $10,000 held over 12 months would cost the investor $60.

Liquidity conditions are poorer than that for platinum. PALL shows an average daily volume of $3 million and an average spread (over the past two months) of 0.33%.

Speculative positioning

Source: CFTC, Orchid Research

Speculators lifted marginally their net long exposure to Nymex palladium in the week to July 30, which is at 50% of open interest.

The net spec length in Nymex palladium has increased by a stronger 82,900 oz over the past month, representing 3% of open interest.

But the net spec length has declined by 141,800 oz or 6% in the year to date.

At 50% of OI, the net spec length in palladium remains below its historical high of 74% of OI established in September 2014. The net spec length is likely to have declined materially since the start of the month considering the 8% sell-off in palladium prices.

This means that there is even more room for speculative buying in favor of Nymex palladium.

Implications for PALL: Palladium’s spec positioning is long, but not excessively long. We therefore think that it is conducive for further speculative buying pressure into year-end, which should have a positive impact on palladium prices, which in turn should benefit PALL.

Investment positioning

Source: Orchid Research

Palladium ETF holdings dropped by nearly 3,300 oz in the week to August 2, marking a 16th straight week of net outflows.

Over the past month, palladium ETF holdings have declined by roughly 17,000 oz, representing a 3% decline.

Since the start of the year, palladium ETF holdings have tumbled by a little bit more than 151,000 oz, corresponding to a 19% drop.

At less than 700,000 oz, global palladium ETF holdings are unlikely to balance fully the expected deficit in the palladium market this year, expected to reach around 800,000 oz according to Johnson Matthey.

Implications for PALL: Despite steady ETF outflows from palladium holdings, the palladium market remains tight because demand ex-investment continues to outpace supply trends. In this environment, we do not expect ETF selling in palladium to have a material impact on palladium spot prices, and therefore, PALL should remain resilient.

Supply trends

While we discussed automotive demand for palladium in China in our previous weekly publication, we wish to provide a discussion about the outlook for palladium production in this week’s report.

Nornickel – the world’s largest palladium producer – reported a palladium production of 1.533 million oz in H1 2019, marking an increase of 10% from a year ago. This was due to 1)the release of work-in-progress inventory at Krasnoyarsk Precious Metals Refinery and 2)higher PGM content nickel matte being processed at Harjavalta.

Although the current company’s guidance (2.770-2.800 million oz for the whole of 2019) implies a decline of 300,000 oz in palladium production in H2 vs H1, Nornickel has a tendency to respect its guidance for H1 and exceed it for H2.

Nornickel forecasts an increase of 3% in Russian palladium production, and an increase of 4% in global palladium production.

The recent company’s reports suggest that palladium production in Russia could prove stronger than initially envisaged, which in turn could reduce the projected deficit.

Implications for PALL: Stronger-than-expected palladium production in Russia in H1 could be maintained in H2, in our view. This could reduce the projected deficit but this won’t be enough to flip the market into a surplus. As the palladium market is set to remain tight, PALL should continue to be supported.

Closing thoughts

Although we acknowledge the recently violent sell-off in PALL, we believe that the long-term appreciation in PALL is not in danger. Like base metals, palladium was hit hard by the double whammy of a stronger dollar and a weaker risk-taking appetite on increased trade tensions.

But fundamentally, the palladium market remains in a structural deficit, despite weaker-than-expected auto sales and stronger-than-expected Russian palladium production in H1.

As a result, we expect PALL to enjoy some buying on the dips in the second half of August, especially considering that palladium’s spec positioning has probably become much lighter after last week’s brutal sell-off.

Against this, we retain our August target for PALL is at $153 per share, which now implies a rally of 14% from its current level.

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.

Additional disclosure: Our research has not been prepared in accordance with the legal requirements designed to promote the independence of investment research. Therefore, this material cannot be considered as investment research, a research recommendation, nor a personal recommendation or advice, for regulatory purposes.