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The precious
metals are in the midst of fantastic secular bull markets. And one of the most precious of metals,
platinum, has been getting a lot of attention in recent weeks. With geopolitical strife accentuating
platinum’s current supply shortfalls, speculators have grabbed hold of
this metal and launched its price into a parabolic ascent.
While gold still
remains king of all metals for a variety of fundamental reasons,
platinum is more precious simply because of its price. Its rarity in the earth’s crust
combined with the challenges of economically extracting it keeps its value
typically about twice that of gold.
And like the
trend for virtually all natural resources, global platinum demand has been on
the rise. According to the U.S.
Geological Survey, platinum demand just ten years ago was only 5m ozs. In 2008
demand for the metal that was once considered an unwanted impurity in silver
is expected to exceed 7m ozs. A
40% increase in consumption of one of the most expensive metals on the
planet, in just ten years, is quite impressive.
But this rapid
increase in platinum demand has really strained the suppliers. According to platinum group metals
(PGM) expert Johnson Matthey (JM), in eight of the last nine years the
platinum markets have experienced an imbalance where supply has fallen short
of demand. This of course is a
textbook economic catalyst for rising prices.
And this supply
shortfall is expected to continue for at least the next couple years as news
from South Africa
continues to create uneasiness in the markets. SA is not only the second-largest
producer of gold in the world (China
now holds the number-one spot), but it is the number-one producer of
platinum. And since it provides over 75% of the global platinum
supply, even the slightest hiccup can send waves through this metal’s
tight market.
In 2007 a number of problems
in the SA platinum mining industry led to the end of a seven-year streak of
supply growth. According to JM
there was actually a 2% drop in
annual platinum supply last year.
With demand growing by nearly 3% and supply falling year-over-year
this creates an imbalance that will naturally drive prices higher.
Well new
developments coming out of SA this year have raised even more alarm in the
platinum markets. A country-wide
power shortage has exposed the poor job the horrendous SA government has done
in managing this country’s infrastructure. Because it turned its shoulder on
decades-old warnings of an impending power crisis, the entire country must
now pay the price and absorb major structural shortfalls of electricity from
the national power grid.
This is a
serious issue not only for the SA economy as a whole but especially for the
mining industry. While this
country is blessed with incredible geological structures that host the
world’s largest and richest gold and platinum deposits, deep
subterranean mining operations require immense
power to ventilate and cool the shafts and hoist the ores to the surface.
And the SA
mining industry has been greatly impacted by these power problems. So much so that not only was there a
temporary halt on all mining operations earlier this year, but most of the
largest miners have had to restate their operational guidance to the downside in order to game the
power problems that will likely continue.
On the
development front even the emerging platinum producers must account for these
power issues. One of the larger
developments in the prolific Western
Bushveld mining district
is finding it necessary to adjust its mining plan to account for the risk of
shortages in available grid power.
This project must now consider the expensive
option of diesel-generated power in order to supplement possible grid
shortages or rationing programs.
These SA
problems will not only continue to hinder supply but increase the costs
associated with bringing platinum to market. And this brings us to our next
matter. Will the rising price of
platinum resulting from these supply issues abate the continually growing
demand for this metal?
Well looking at
what is likely the most elastic of platinum’s sectors, jewelry, you wouldn’t think so. With platinum up an impressive 37% in
2007, jewelry demand held up rather well. By JM’s
calculations jewelry demand fell by only about 1.5%
year-over-year with the help of strong demand in China and Europe. We’ll see if $2000+ platinum in
2008 takes more of a chunk out of the jewelry
business.
Interestingly
the bulk of platinum’s demand is not being driven by the preciousness
of the metal, as jewelry accounts for less than 25%
of total demand. And even though
platinum jewelry serves as a status of wealth, unlike gold this metal does not serve as a store of wealth. Platinum is not known as a safe haven
and its investment characteristics just don’t compare to gold.
Platinum’s
primary source of demand and growth
is actually industrial in nature.
Of its many industrial applications it is found in LCDs,
hard disks, oil refining, and the exciting development of fuel cell
technology. And by far the
biggest single consumer of this metal is the automobile industry.
Platinum’s
presence in the automobile industry results from a decades-long environmental
push to reduce automobile emissions of particulate matter, nitrogen oxide,
and hydrocarbons. This push has
led to stringent regulations that now require vehicles to be equipped with
catalytic converters. In
non-technical terms platinum (and the rest of the PGMs
including ruthenium, rhodium, osmium, iridium, and palladium) serves as a catalyst
inside these converters enabling chemical reactions that treat vehicle
exhaust emissions.
Because of
platinum’s incredible catalytic properties, it has largely been the
dominant PGM to comprise these converters. And most people have no idea how much
precious metal they are actually sitting on when they drive. The average catalytic converter
surprisingly houses about 5
grams of PGMs (measured by
platinum in this example). So
this means at today’s prices each vehicle contains roughly $300 worth
of platinum.
And on a side
note platinum is not only a catalyst for emissions, but with its lofty price
it is now a catalyst for thieves.
Provocatively there is a growing epidemic of catalytic converter
thefts. A well-trained thief can
remove a catalytic converter from a parked car in less than one minute and
pawn it off for a hefty chunk of change to willing buyers that illegally
recycle the metal.
Shifting to
economics, for a car that retails at $20k its PGM component at today’s
prices accounts for about 1.5% of the cost. And this percentage is even higher
pre-markup for the manufacturers. So in an industry with already-tight
margins a skyrocketing platinum price (this year alone platinum is up an
impressive 39%!) is sure to hurt
the bottom line.
Ultimately
automobile manufacturers do not have a choice and must pay the going price
for the metals that comprise their vehicles. Much of this obviously gets passed on
to the consumer, but the manufacturers aggressively seek to control costs and
are finding methods to do so even in catalytic converters.
Interestingly in
gasoline-engine vehicles platinum is not the only PGM that serves as an
effective catalyst to control emissions.
While palladium’s properties don’t convert emissions as
efficiently as platinum, gasoline-engine catalytic converters are able to
contain a higher percentage of this PGM and still meet code.
And this cheaper
PGM alternative is very appealing to the manufacturers. In recent years the price of palladium
has been running about a quarter the value of platinum. Because of this palladium is actually
overtaking platinum as the PGM of choice in gasoline-engine catalysts. In fact, according to JM, there is a
running five-year decline in the use of platinum in gasoline-engine
catalysts.
This of course
has led to growing auto-catalyst demand for palladium, an 8% year-over-year
increase in 2007, and has been the primary driver of an overall 2% demand
increase for this metal. JM
estimates that the proportion of palladium now used in the manufacturing of
gasoline-engine catalytic converters now exceeds 75% of the PGM load.
But as you can
see in this chart, palladium’s bull market has not reflected the
continually growing demand for this metal. And the reason for this is its
economic imbalance is skewed inverse to platinum’s due to an actual oversupply. This is countertrend to not only
platinum but nearly the entire commodities complex.
Interestingly
this oversupply is in large part due to Russia’s
massive palladium stockpiles.
These stockpiles are the result of aggressive palladium accumulation
in the 1970s and 1980s. And once
the strategic nature of this metal was deemed non-strategic, Russia
began releasing its surplus to the markets beginning in the 1990s. Other than the bubble in 2000, Russia’s
endeavors have indeed suppressed palladium’s
price until recently.
As for this
bubble not surprisingly Russia
was the impetus of this volatility as fears emerged that it would stop
releasing its stockpiles. This
led to Ford Motors’ gaffe of over-speculating the market to game Russia’s
purported supply stoppage. Ford
of course bet wrong as Russia
continues to pilfer its stockpiles to this day. Currently palladium supply is about 25% greater than demand, and this is
usually a recipe for swiftly declining prices.
But even with
this oversupply, the price of palladium has noticeably marched higher to break through its long-time
non-bubble $200 barrier. Zooming
in on the last few years, we can see in this next chart that palladium
finally broke out of its funk and surprisingly began an impressive bull
market of its own.
The overall
strength in the PGM complex finally started to rub off on palladium in the
second half of 2005. Since its
low of $174 in July 2005 palladium has soared over 200% to reach a recent
six-year high. And in 2008 alone
it is up a whopping 47%!
But this rally
still doesn’t make sense from a fundamental perspective. With such a large surplus, prices
shouldn’t be rising in this fashion. Well with a three-year run to the
upside the markets seem convinced that pricing palladium higher in the face
of oversupply is the appropriate course of action.
There are a
number of factors that I suspect go into this unusual trend. First it seems logical that palladium
is just piggybacking platinum’s strength. It is running a fairly tight
correlation of 0.895 with platinum since 2005 and is sporting an r-square of
80%. This means that 80% of the
daily behavior of palladium can be explained by the
daily behavior of platinum.
It is also rumored that Russia is quickly running out of
its palladium stockpiles. If this
supply channel suddenly halts then the mined and recycled palladium supply
would be really tight with demand.
Interestingly according to JM palladium supply from the miners was
actually down by about 5% in 2007.
So perhaps palladium’s strong levels are a result of traders
gaming a not-too-distant-in-the-future shortage of the metal.
Whether riding
platinum’s coattails or betting on future supply problems this metal is
showing incredible strength. And
demand for palladium should continue to grow both on the auto-catalyst front
as well as in the jewelry sector. This growth will come not only as a
platinum substitute, but on the heels of a fast-growing global auto market.
Back to
platinum, you may be wondering how this metal could possibly be running a
supply deficit considering its use in gasoline auto-catalysts is trending
down. Well gasoline is the key
word here. Interestingly platinum’s
role in the auto-catalyst sector is primarily driven by diesel-engine
vehicles.
While in the U.S. the only diesel vehicles we typically see
are trucks, the rest of the world, especially Europe,
is seeing incredible growth in diesel.
And much of this growth is driven by fuel economy. European drivers in particular pay
vastly more to fuel their vehicles than Americans, thus actually creating an
incentive to improve energy efficiency.
And diesel-engine vehicles indeed provide much better fuel economy.
Platinum comes
into play as a result of diesel’s much higher levels of emitted
pollutants versus the gasoline engine.
These increased pollutants must still be controlled and are in turn
counteracted by a more efficient filtration system. Since diesel engines, or
compression-ignition engines, operate at a high-temperature permanence they
need a more “active” catalyst. And platinum is the qualified member
of the PGMs hosting the acceptable physical and
atomic properties.
Up until
recently platinum was the only PGM
loaded in catalytic converters in diesel-engine vehicles. But palladium can now be used
sparingly. Even with this
palladium creep though, according to JM platinum still covers around 90% of
the PGMs currently used in diesel-engine catalysts.
And with
regulations only tightening up in the future, platinum should continue to dominate
the diesel-engine market.
Ultimately even with palladium chipping away at platinum in the
auto-catalyst sector, according to JM platinum demand from the auto industry
still rose by over 2% in 2007.
And with over
50% of the passenger vehicles sold in Europe now diesel coupled with a
super-hot global auto market led by Asia,
platinum demand from the auto-catalyst sector is not likely to subside. According to JM 61% and 66% of
platinum and palladium demand respectively comes from the auto-catalyst sector. And this sector will continue to
dominate the economics of PGMs going forward.
Another factor
that has and will have an effect on PGM fundamentals is ETFs. In 2007 platinum and palladium ETFs launched in Europe
and of course caused some excitement.
And since these ETFs are backed by the
physical metals they have indeed pinched the liquidity of above-ground
stockpiles.
I’ve seen
estimates that PGM ETFs already account for up to
5% of total annual platinum demand.
And this absolutely affects the market for this metal. So much so that the ETFs may single-handedly be responsible for supply
deficits in the coming years.
Platinum investment is perhaps taking a page out of gold’s book.
More and more
interest in the current PGM ETFs and perhaps new ones
hitting the market really have consumers of the metals nervous. The PGMs
have such a small market relative to other commodities that mainstream
investor and speculator interest could really be disruptive from a liquidity
standpoint.
In 2007 there was
even chatter that several banks were attempting to launch US-based PGM ETFs. With
the successes of the big gold and silver ETFs in
the States a PGM ETF would likely attract great interest. But most folks believe this will never
happen as the custodians dropped their ETF bids when they realized there was
a slim chance of ever getting them approved by the SEC.
Ultimately
researching and learning about the PGMs brings us
to our primary focus, profitably trading these metals. While trading futures and European ETFs is certainly a good way to go, the average North
American investor simply does not have access to these vehicles.
At Zeal we
prefer to invest and speculate in the commodities bull markets through the
stocks of the companies that explore, develop, and produce the
commodities. Investing in stocks
certainly comes with individual company risk, but the right companies can be
highly leveraged to the performance of their underlying commodity and can
provide investors with legendary gains.
Unfortunately on
the platinum and palladium fronts there a not many miners that generate their
primary source of revenues from these metals. These markets are still very small
(about one-seventh that of gold measured by market capitalization) and the
barriers-to-entry are enormous.
And though there is a growing number of primary-PGM explorers starting
to hit the markets, the producers are few and far between.
Provocatively I
have found that gold serves as one of the best proxies to trade
platinum. And if this next chart
doesn’t give you a stimulating visual picture of the relationship
between these two metals’ respective bull markets, then the
mathematical correlation ought to.
Since the beginning
of 2002 gold and platinum have had a stunningly-tight daily price correlation
of 0.979 with an r-square of an incredible 96%. With this type of correlation these
metals have so far in their secular bulls proven to run near-lockstep with
each other on a daily basis.
We can also use
correlation analysis to show that gold
stocks follow platinum closer than even platinum stocks do! Using Stillwater Mining (SWC) and
North American Palladium (PAL) as examples, their correlations with platinum
come in at 0.194 and 0.425 respectively.
This translates to r-squares of 4% and 18%, almost no correlation at
all with platinum. Only in their
recent parabolic ascents have these stocks been the least bit enticing to
traders.
Now take these poor
correlations and contrast them to gold stocks and platinum. Since gold and platinum have a tight
correlation, and from past studies we know that gold stocks and gold have a
tight correlation, then gold stocks and platinum ought to have a tight correlation. Measured by the venerable HUI
gold-stock index, gold stocks indeed prove to have an impressive daily
correlation with platinum of 0.960 with an r-square of 92%.
Ultimately I am
very bullish on platinum even though I believe euphoria currently has a grip
on this metal. And the producers
of the PGMs should be wildly profitable if they are
managed well. But it is still
apparent that gold stocks provide a better proxy to play platinum in the
stock markets.
In our acclaimed monthly newsletter we publish a
Watch List of stocks within various commodities sectors that pique our
interest. And while a handful of
PGM stocks seem to cycle through this list each month, we continue to find
that the gold stocks offer the highest probability for large gains.
And since these
gold stocks, and even silver stocks for this matter, provide the best
correlation and leverage to the entire precious metals complex, our focus
lies here on the trading front.
If you are looking for high-probability-for-success stock picks and an
action-packed newsletter dialed-in on the
commodities markets, then subscribe today!
The bottom line
is PGM demand continues to grow led by the auto-catalyst sector. But a growing number of problems on
the supply side of the metal have been cause for growing concern among
traders. And this concern has manifested
itself into wild parabolas that are likely to correct hard once these markets
stabilize and the speculators exit stage left.
But even upon
stabilization PGM prices are likely to consolidate on the high side. And since platinum and most likely
palladium are still in the first half of spectacular secular bull markets,
high prices are probably here to stay.
Traders who have been betting long on the physical metals in recent
years have seen legendary gains.
But for stock market investors and speculators, so far gold stocks
have been the best vehicles to leverage the PGM bulls.
Scott
Wright
Fébruary 29, 2008
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Thoughts, comments, or flames? Fire away at scottq@zealllc.com .
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