- Despite the sharp sell-off in PALL at the end of February, we remain bullish on palladium, due to its tight fundamentals.
- PALL reached our Feb-20 target of $245 on Wednesday, February 19, having rallied by 12% on the month.
- Speculators remain bearish on palladium. ETF investors bought some dips last week.
- Fundamentals of the palladium market are solid, with a refined market deficit likely to exceed 1 million oz this year.
- For March, we set a target of the Nymex palladium spot price at $2,900 per oz, implying a target for PALL at $274 per share.
Welcome to Orchid's Palladium Weekly report, in which we discuss palladium prices through the lens of the Aberdeen Standard Physical Palladium Shares ETF (NYSEARCA:PALL).
In the face of the sharp sell-off in PALL (-12%) during the last trading day of February, it is important to take perspective. Despite the sell-off in PALL last week, PALL managed to rally by around 12% in February, after a gain of 18% in January. Among the precious metals space, palladium remains the best performer on the year, after a gain of 50% in 2019.
While the sharp sell-off on February 28 took us (and many market observers) by surprise, we have not panicked. Rather, we sit tight and maintain our bullish view on PALL, due to its structurally tight fundamentals.
The broad-based sell-off across the precious metals space suggests that the sell-off in PALL was driven by macro-factors rather than micro-dynamics. We, therefore, view the sell-off as a buying opportunity.
As a reminder, we have been bullish on PALL for months, thereby benefiting greatly from the substantial rise in palladium prices.
It is, in this vein, that we are contemplating to buy the dips in PALL. We expect PALL to reach a high of $274 per share in March.
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%.
Source: CFTC, Orchid Research
Speculators cut markedly their net long position in Nymex palladium in the week to February 25, marking a 6th straight week of spec selling. The palladium spot price rallied by 5.1% over February 18-25, registering the strongest performance among the precious metals complex. This suggests the presence of OTC buying activity, offsetting the spec selling activity.
The net spec length in Nymex palladium is very light in so far as it represents just 24% of OI, significantly below its historical high of 73% of OI established in September 2014.
The absence of speculative buying pressure so far this year despite the appreciation of nearly 40% in the Nymex palladium spot price confirms our view that its price strength is driven by its presently tight fundamental dynamics.
Implications for PALL: There is a risk that the speculative community re-enters the palladium market in response to the recent dip. If spec sentiment swings positively, the Nymex palladium spot price could rise even more, which, in turn, would push PALL further higher.
Source: Orchid Research
ETF investors added a small 3 tonnes to their palladium holdings in the week to February 28, marking the first week of inflows over the past 7. The palladium spot price dropped 3.2% over the corresponding period.
The negative co-movement between ETF flows and palladium prices is a sign of a tight physical market. Given the supply-demand imbalance, ETF investors require a higher palladium price to release some supply to the market.
When palladium prices decline, ETF holders sit tight, while new ETF investors are prompted to accumulate some metal at a cheaper price.
Implications for PALL: ETF outflows since the start of the year are driven by the appreciation in the Nymex palladium spot price. As such, we do not view ETF liquidation as a negative factor for PALL.
Another year of deficit in 2020
Johnson Matthey estimates that the deficit in the palladium market widened to nearly 1.2 million ounces in 2019 (17% of primary supply), the deepest in five years. This was driven by a combination of weaker production and stronger demand.
Source: Johnson Matthey
Johnson Matthey expects an even deeper deficit in 2020, driven by a further increase in automotive demand (on stricter emission legislations in China and Europe) and constrained output growth.
Given the extremely low level of visible inventories, the risk of physical shortage is very real this year.
Implications for PALL: The meaningfully tight fundamentals of the palladium market should continue to support the Nymex palladium spot price in 2020, which, in turn, should pressure PALL higher.
We view the significant sell-off in PALL on February 28 as a great opportunity to buy the dips. The sell-off was macro-driven and therefore, inconsistent with palladium’s tight fundamentals.
Given the structural deficit of the palladium market, we expect the uptrend in PALL to prevail in March.
Visible inventories are at a critically low level that investors should consider the risk of physical shortage as elevated this year.
We expect PALL to reach $274 per share in the course of March.
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