Sprott Physical Platinum & Palladium Trust: Autocatalyst Demand Uncertainty To Weigh On Sentiment
- SPPP invests in physical bullion at a ratio of ~82% palladium and ~18% platinum.
- The platinum group metals 'PGMs' face balancing bullish and bearish trends considering positive sentiment towards precious metals against more uncertain industrial demand.
- SPPP is a good option to gain exposure to price trends in PGMs in a structure that has some advantages over owning physical including preferential tax treatment .
- This idea was discussed in more depth with members of my private investing community, Core-Satellite Dossier. Get started today »
The Sprott Physical Platinum & Palladium Trust (NYSE:NYSEARCA:SPPP) is a closed-end-fund with $132 million in total assets. As the name implies, the fund invests in both platinum and palladium with shares backed by corresponding physical bullion. Palladium, in particular, has gained importance among precious metals considering its surge over the past year to a high above $2,800 per ounce and now more valuable than platinum and gold.
Indeed, a combination of tight global supplies and increasing use in more advanced catalytic converters from the automobile industry have represented strong fundamental tailwinds. On the other hand, the current global slowdown and more recent macro uncertainties threaten to reverse sentiment towards PGMs as industrial metals. We expect the conflicting factors to generate higher volatility for the year ahead but think SPPP has a solid structure to gain long-term exposure.
SPPP Trust Background
The unique aspect of this fund is that all shares are fully backed and allocated to physical bullion in custody with the Royal Canadian Mint owned by the Government of Canada, recognized for its "AAA" credit rating. In this regard, beyond a financial instrument, SPPP is an alternative to owning platinum and palladium bars or coins. There is an option for delivery, although it requires a minimum holding of 25,000 units, or investment value of roughly $425,000 at current prices, and additional fees. The fund notes that since inception through the end of 2018, over 18,000,000 units have been redeemed for delivery highlighting the popularity of the feature.
There is a tax advantage to this fund structure for U.S. investors, as the long-term capital gains tax on holding SPPP is 15% (20% for higher tax bracket individuals) compared to the 28% normally applied to precious metals ETFs and direct physical investments. While this may not be relevant to some short-term traders, we think this format makes SPPP an especially good option for long-term investors of this market segment. Keep in mind, Sprott has an alternative fund with a similar fund structure for gold (PHYS), silver (PSLV), and a combination fund of gold and silver with the Sprott Physical Gold and Silver Trust (CEF).
As it relates to platinum and palladium, shares of SPPP currently represent a physical ratio of 17% platinum and 82% palladium. The remaining ~1% is in a cash market fund. This ratio corresponds to 23,177 ounces of platinum representing $22.3 million and 46,856 in palladium representing $107.2 million as of January 31, 2020. The fund's expense ratio of 1.32% is comprised of a management fee of 0.50% and operating fees of 0.82% which includes the logistical storage expenses and custody of the fund's bullion. In this context, the actual management fee is comparable to alternative ETFs in the category. The Aberdeen Standard Physical Palladium Shares ETF (PALL) for example features an expense ratio of 0.60%.
SPPP had an exceptionally strong year in 2019, returning 46% on its market price. As we explain below, this was driven by the surge in the palladium which climbed 60% in 2019. The fund includes benchmark data for both the spot price of platinum and palladium along with the daily settlement of the London Bullion Market Association 'LMBA' daily auction.
With official fund data through January 31st, 2020, SPPP NAV returned 56.1% compared to a 66.3% return for palladium LBMA price and 16.8% for platinum LBMA price. Keep in mind that the actual allocation between the two metals may vary over time and the strong gain in the price of one will further skew the holding ratio. By this measure, historical performance data of SPPP since inception in 2012 is not comparable to the current 82/17 composition. For reference, the fund is up 18% year to date through March 6th, 2020.
SPPP Price Drivers
Platinum and palladium are valued in large part for their industrial uses. The primary demand driver for both metals is in the manufacturing of catalytic converters which reduce toxic and polluting emissions from automotive exhaust. Autocatalyst demand is said to represent 81% of palladium use and 39% of platinum. The case here is that tighter emissions standards globally have required more advanced and technically efficient catalytic converters in recent years for both gasoline and diesel engines.
Automobile manufacturers are simply requiring more palladium in every gasoline-powered vehicle, representing a surge in demand for the commodity. The advantage of palladium to platinum in gasoline-based engine catalytic converters is its higher efficiency and durability. The fundamental dynamic is further supported by a recurring market deficit of palladium and limited mining production growth globally.
On the other hand, the scenario is nearly the polar opposite for platinum that has traditionally been the preferred metal for use in catalytic converters in diesel engines. In this regard, a declining proportion of diesel vehicles being manufactured and sold, particularly in Europe, have represented a natural pressure on platinum demand. The share of diesel-based vehicles sold in Europe in 2018 fell to 36% from levels above 50% in 2013 and expected to decline further as some auto manufactures are phasing out the fuel type.
Technological advances in recent years from gasoline engines have narrowed the advantages that diesel engines previously had in terms of power and torque. Diesel engines are also known as being more polluting, incentivizing auto manufacturers to produce comparable gasoline-powered alternatives. The current price of platinum trading under $900 per ounce has steadily declined from a high near $1,900 in 2011.
According to Russia's Norilsk Nickel PJSC (OTC:NILSY), the world's largest producer of palladium, the market balance for palladium has been in a deficit since 2012 and expected to rise from 0.6 million ounces (600k) in 2019 to 900k in 2020 for palladium 'Pd'. The mining giant also notes that even as automobile production and sales have been weaker globally going back to 2018, the higher requirement or "loading" of palladium in each catalytic converter has balanced some of the market trends.
For platinum 'Pt', there was a surplus of 800k ounces in 2019 which is expected to reduce to 300k in 2020. The price-performance has reflected these divergent fundamental factors.
Analysis And Forward-Looking Commentary
Remembering that SPPP is allocated between 82% palladium and 17% platinum, the composition is favorably tilted towards the metal benefiting from the more positive fundamental trends. Palladium has been exceptionally volatile into 2020 following its impressive rally over the past year to a high of $2875 in late February. The current price under $2,400 is now down nearly 20% from that high, but still up about 12% in 2020.
Our view is that the current macro environment considering the ongoing global COVID-19 outbreak and deteriorating economic outlook represent bearish trends for both platinum and palladium as industrial metals. If fewer vehicles are going to be manufactured and sold, the demand for palladium has downside from prior forecasts. Platinum, already pressured by the market surplus, can also be weighed down by weaker jewelry demand in a cyclical downturn.
While recognizing the long-term trends for palladium are positive, we think the near-term bearish macro trends and outlook for the automobile industry will weigh on sentiment. We think that the low interest rate environment including the recent rate cuts by the Fed and global central banks following dovish monetary policy can benefit gold more as a store of value and safe-haven asset. Platinum and palladium are likely pressured given their greater industrial aspects.
The Sprott Physical Platinum and Palladium Trust is a quality fund and a good option to gain long-term exposure to trends in the two commodities. Palladium has benefited from some powerful bullish fundamental factors in recent years including increasing demand and a market deficit although we think the near-term outlook has weakened given increasing macro uncertainties.
If platinum and palladium are viewed more-so as industrial metals, the current environment is bearish as expectations from the autocatalyst demand have a downside. The outlook for China and global growth expectations will be an important monitoring point going forward for all commodities. A fast containment of the coronavirus and strong recovery of global growth represent the upside for SPPP from the current levels. All-in-all, we see risks tilted to the downside in the near term but have a long-term positive view for the fund.
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This article was written by
BOOX Research is now Dan Victor, CFA
15 years of professional experience in capital markets and investment management at major financial institutions.
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