Often lost in
the shuffle and the talk about gold and silver as the primary precious metals
is another metal, which has uses that rival that of silver, is brilliant in
appearance and makes a beautiful coin. Its value has quadrupled since 2003
after seeing an all-time high in 2001, and potentially the best aspect yet is
that the supply and demand fundamentals have never been better. Guess it yet?
I'm talking about palladium. Over the next several pages, we'll take a look
at the many uses for palladium, who the big
producers and consumers are, prices, and most importantly, the future
outlook. The purpose of this article is not to form specific recommendations,
but rather to raise awareness of another of the semi-precious metals and to
act as a primer for familiarizing people on its fundamentals.
By way of
introduction, let me say first that palladium does not have a rich heritage
as a monetary metal like gold and silver. Rather, it is akin to platinum in
that you can buy coins (Maple Leafs and bars) rather easily, but they will
not be as recognizable by and large as their gold and silver counterparts.
The metal is more of an industrial metal, which one might immediately think
is bad because by definition, it is susceptible to swings in economic output.
This would be true, however, as is the case with energy and other products,
we must keep in mind the interlocking nature of the global economy and that
we need to be focused on aggregate demand as in global demand, not aggregate
demand as in sub-regional or regional demand. Palladium is also not an
effective inflation hedge. Looking at historical prices through 2006, you'll
quickly notice that the peak was in 2001, hardly the pinnacle of dollar
destruction. However, over the past several years, palladium, like most other
commodities, has trended upwards as the dollar has come under increased
attack.
Palladium's
Uses
Probably the
most well known use of palladium is in autocatalysts or catalytic converters. These can be made
of platinum as well, however, palladium has several
advantages over its top-shelf counterpart. It is more resistant to oxidation,
meaning it will last longer in catalytic applications, is softer and more
ductile, and is generally cheaper than platinum. Auto-catalysts are by far
the biggest use for palladium at the moment and such catalysts are even
present in hybrid cars as well, meaning demand is not likely to be adversely
affected even as many car owners switch to hybrids in the coming years. One
possible risk to palladium demand would be a revolutionary breakthrough on
the electric/solar/LNG side, which would make it feasible for a large amount
of car owners to affordably switch to the new technology. There are certainly
examples of these, but they are by no means a threat at this point and I
wouldn't foresee such developments becoming an issue over the next several
years at a minimum. These types of major changes are generally slow to occur.
As of 2009, roughly 45% of palladium was used in autocatalysts.
This number was down from over 53% in 2003, which bodes well for the
diversity of uses for the metal. .
A second
popular use for palladium is in electronics. Its metallic characteristics
make it a very suitable substitute for gold in plating of sensitive
electronic components. The fact that it costs roughly half that of gold makes
is a shining example of the substitution effect in practice. As of 2009,
around 15% of palladium consumed went into electronic components. Jewelry
accounted for roughly 14% of palladium used in 2009. Investment in the metal
accounted for 10% of 2009 demand. This is very important because in the
earlier part of the decade, investment in palladium was trivial at best despite
the fact that the metal had very recently been at a record high. Interest has
been multiplying significantly, however, most metals
investors still have yet to make their first purchases of palladium.
Rounding out
the balance of Pd's uses are dentistry and chemical
refining, where it is used to develop raw materials for use in synthetic
rubber, polyester, and nylon. It is also utilized in oil refining where it is
present in several types of hydrocracking applications, photography, water
treatment, hydrogen purification, and medicine. Like silver, there are many
diverse uses for palladium and this fact alone bodes well in that it serves
to insulate prices somewhat from the stagnating USEconomy.
Palladium
Supply and Demand
As of 2003,
the situation with regards to palladium was eerily similar to that of the
rare earth metals in that much of the globe's resource base was concentrated
into a very small oligopoly of producers. In that year, nearly 80% of global
palladium production came either from the Russian Federation or South Africa.
By 2010, Russia was largely tapped out of palladium. Its purported massive
stockpiles were diminished to nothing and its three biggest mining projects
were all in advanced stages of decline. Russia has been supplementing mine
production from its Norilsk mining company with sales from Gokhran, the state repository (a stockpile), and the
Russian Central Bank – obviously another stockpile. In early 2010 Anton
Berlin, a director of Norilsk, stated that there
would likely be no sales from the Russian repositories in 2011.
While the
exact content of Russia's stockpiles is not for public consumption, Mr.
Berlin did confirm that sales out of the stockpiles have been declining since
early in the decade. At this point, the largest palladium deposit on earth
exists in South Africa in the form of the Bushveld
Complex. Currently, the only other producing nation that has significant
upside potential in terms of production is Zimbabwe. However, it is a locale
that is loaded with political risk among other things at this stage of the
game. There are currently several projects going on in North America, the
most promising of which exists at Thunder Bay, which could end up producing
nearly 40 million ounces of palladium. It must also be understood that the
projects in the Thunder Bay area are for the most part in their infancy and
real production is likely several years down the road.
The market
will need every ounce from these projects because light vehicle production is
set to increase through 2016. If you're worried about a worsening of the US
recession killing off demand, consider the fact that China is outpacing
America in terms of putting new cars on the road. There are several other
jurisdictions like India and Brazil where more stable economic environments
will lead to growth in middle classes that will take to the road as well.
Remember; consider aggregate demand, not just regional demand. Other factors
that will provide upward pressure on palladium usage are increases in
investment demand, medical uses, and, in particular, the petroleum industry
as shrinking supplies of crude oil demand even more efficient refining
techniques. Palladium has also been a part of many of the early work in fuel
cell technology and while it is impossible to gauge what the impact will be
at this stage, fuel cells will clearly be in focus as the world comes to
grips with peak oil and seeks suitable alternatives.
Summary
and Outlook
Palladium has
several big advantages over many of the other metals in the commodity space.
First, it is practical in terms of holding a physical position should one
desire. Compare it to copper, for example, where a $1000 position requires
you to hold over 200 pounds of metal. Or consider oil where it is not
practical for the average investor to hold a physical position at all. As I
outlined above, supply and demand dynamics favor higher prices in the future,
and while it was not the focus of this article, there are some very
significant opportunities in the palladium mining space for those who wish to
take advantage in that manner. The obvious risks to palladium are the same as
the other industrial metals. Another severe global recession would likely
dampen demand enough to keep prices in check. Such a recession/crisis, if it
were to impact the capital markets as we saw in 2008, would likely impair
mining firms (especially exploration/development types) from getting the
necessary capital to fund their continuing operations. Innovation, especially
in the automobile space, represents a risk to the current demand profile for
palladium, but innovation also presents more potential uses for the metal as
well.
The bottom
line on palladium is that while it is certainly not the sole answer to
protection against dollar destruction, there are some very compelling aspects
to the market that make it worthy of serious consideration. It is yet another
tool that we can use to operate in a world that is becoming increasingly wary
of paper monetary instruments and will likely benefit as the world continues
the quiet, but relentless push to 'get real' by acquiring tangible assets.
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Andrew W. Sutton, MBA
Chief Market Strategist
Sutton &
Associates, LLC
Interested in what is going on in the markets and
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