By: Rick Rule, David Franklin, David Baker and Shree Kargutkar
Hard assets are gaining momentum once again as market participants digest the potential impact of central bank printing initiatives. After last year’s record level of central bank intervention, 2013 is gearing up to be an even more prolific year on the money-printing front.1 Japanese Prime Minister Shinzo Abe recently unveiled Japan’s tenth Quantitative Easing program to follow the country’s current $224 billion stimulus announced on January 11th. The US Federal Reserve is steadily printing US$85 billion a month under its QE3 & QE4 programs, and reports indicate that the European Central Bank is close to launching its much-awaited Open Market Transaction (OMT) program to purchase European sovereign debt. It’s a money-printing party and everyone’s invited. Even the new Bank of England head, Mark Carney, has hinted of plans to launch more monetary stimulus.2
Professional investors have noticed and are expressing concern over the consequences of concerted currency devaluation and the continuation of zero-percent interest rates. PIMCO’s Bill Gross, aka “The Bond King”, is now regularly touting gold and hard assets as a prudent investment in 2013.3 While his advice appears to have fallen on deaf ears, interest in inflation protection is once again on the rise. We continue to believe that precious metals remain the place to be invested in this environment and are always interested in different avenues with which to participate in the sector’s inevitable rise.
Despite being long-time precious metals enthusiasts and active investors in gold and silver, we did not focus on “the other precious metals”, platinum or palladium, until very recently. Our interest in the space was ignited by a client’s request to assess investment opportunities in the debt and equity of Platinum Group Metal (PGM) mining companies – an exercise that came up almost completely dry. As long-time resource equity investors, we are familiar with the mining industry’s supply/demand cyclicality and the impact it has on commodity prices. Looking more closely at the PGM miners, the platinum and palladium industry reminds us of the uranium industry back in 2003. Like uranium, platinum and palladium are crucial to a number of important industrial applications where demand for them is relatively inelastic to price. And like uranium in 2003, palladium is also marked by an opaque, but rapidly diminishing foreign supply stockpile, which had previously balanced out the market and effectively capped the price. Investors will remember that uranium proceeded to perform extremely well from 2003 onwards based on the fundamental supply/demand imbalances that ensued. Our assessment of the PGM industry has led us to believe that platinum and palladium have the potential to do the same. The one difference being, however, that whereas in uranium, where we chose to build our exposure primarily through uranium mining equities, platinum and palladium exposure appears to be best gained through the metals themselves… hence the launch of the Sprott Physical Platinum & Palladium Trust this past December (NYSE Arca: SPPP, TSX: PPT.U).
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PALLADIUM
The palladium story is similar to that for platinum from a demand perspective, but has a different supply picture that makes it more compelling in our view. Palladium generally occurs with platinum and other PGM metals and is usually associated with nickel and copper. Like platinum, palladium’s main industrial usage is in catalytic converters, most notably in gasoline engines. It is also used in jewellery, watchmaking, dentistry, surgical instruments and electrical contacts.
Almost 40% of the world’s annual palladium mine supply comes from Russia, primarily through operations at Norilsk. Russia, naturally, does not provide much information on its palladium stockpiles, but various reporting agencies are able to piece together reliable estimates for annual supply and demand.
The palladium market is tight, and appears to be getting tighter. It has gone from a 1.26 million ounce surplus in 2011 to a 915,000 ounce deficit in 2012. This represents a swing of over 2 million ounces this year due to contracting supply, increasing gross demand and diminished recycling, resulting in a supply decrease of 790,000 ounces (see Figure E). If you factor in the ~200,000 ounces we purchased in our Trust, the deficit for 2012 increases to 1.15 million oz.11
As bullish as we are on the supply dynamics of platinum, it is palladium that appears to be poised to move higher in the short-term. The palladium market is now in supply deficit globally and will experience a residual deficit in 2013 even after existing stockpile sales are taken into account. Russia has historically maintained a sizeable palladium stockpile which has represented a key source of supply over the past two decades. 2012 reports suggested that that stockpile was nearing depletion, with sales expected to fall below 100,000 ounces in 2013, versus the 250,000 ounces that are believed to have been sold last year.12Those numbers were also supported by Swiss PGM data, where the most recent 2012 numbers show Russian palladium shipments running 72% lower than the same period in 2011.13 All of this was recently confirmed by Norilsk itself, when an executive conceded in an interview on November 29th (and later confirmed by industry watchers like GFMS this past January) that the supply overhang from Russian stockpiles is officially close to being depleted. If this proves to be true, it will represent a significant shift in supply, since those stockpiles were a main contributor in balancing the palladium market for the last ten years.
FIGURE E
Source: Johnson Matthey Platinum 2012 Interim Review
One other bullish palladium supply factor relates to the Norilsk mines themselves, which produce more palladium than the next four largest palladium producers combined. Norilsk’s 2012 palladium production is expected to account for 42% of global supply. Despite higher prices, Norilsk is not expected to expand its annual palladium production for at least 10 years, because that’s how long it will take to develop the new mines it requires to increase production. In addition, the existing operations are reported to be having difficulty maintaining their average 2.7 million ounces of annual production due to diminishing ore grades at depth within the ore bodies Norilsk is mining. With Russian state supplies dwindling, and Norilsk’s palladium production flat at best, the supply picture in 2013 has a very high probability of tightening further. This is especially likely if South Africa’s 1.5 million ounces of palladium production is also impacted by further strikes and mine shutdowns.
Palladium demand has been robust, having risen by 15% year-over-year in 2012 to 9.73 million ounces.14The growth has been primarily driven by increased use in autocatalysts, the demand for which alone is forecasted to increase by 7% in 2013. Given the probability of tightening supply in the years ahead, we could potentially see a hoarding reaction by industry users as supply constraints become more pronounced. In year 2000, a similar reaction by industry users led palladium to trade over $1,000/ ounce. It is also interesting to note that palladium has the second highest amount of short positions in the futures market in relation to total annual production – second only to that for silver. The reversal of those short contracts may represent a significant source of investment demand as prices continue to rise.15
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