With the price of gold up by more than $100 (£77) an ounce in six months, investors in the barbarous relic have a reason to smile. But during that time, one precious metal has shone brighter. Palladium, which is commonly mined alongside platinum and primarily used in the auto industry, recently hit a price record, capping a three-year rise to pass $1,500 an ounce.
After a recent dip in prices, the metal currently trades at $1,380 an ounce, making it 6 per cent more valuable than gold. But that’s where the comparisons should probably stop. Although gold has been a long-term store of value for millennia, demand for palladium is resolutely industrial. And in the relatively young history of this metal, palladium price spikes tend to correct.
For investors in the metal’s miners, such as Tharisa (THS) and Lonmin (LMI), the key question now is whether supply and demand dynamics will cause a price crash as sharp as the rise.
The auto-catalyst
Palladium’s spectacular ascent has arguably been several years in the making, key to which has been the metal’s relationship with platinum.
Although palladium is sometimes used in coins or jewellery, its primary application is within catalytic converters in gasoline-powered combustion engines, where it reacts with and scrubs harmful emissions such as carbon monoxide and nitrogen oxide. This demand is very concentrated. According to research from Johnson Matthey (JMAT), automakers make up around 80 per cent of global demand for the metal.
By comparison, platinum’s end markets are more diverse, with auto-catalyst makers comprising just 39 per cent of last year’s total demand of 7.83m ounces. In recent years, that demand has been falling, as consumers have turned away from diesel-powered vehicles, which typically use more platinum. With the market awash with supply, prices have more than halved since 2011.
However, for much of this time, platinum still commanded a wide premium to palladium, which in turn fed a switch to the latter. Concurrently, rising emissions standards have led to increased use of palladium in catalytic converters. This trend has been particularly strong in China, where palladium imports have been surging despite a soft domestic car market. A rise in scrapping, and continued heavy liquidation by exchange traded commodity (ETC) funds’ holdings has so far failed to redress the balance.
Sustained highs?
Forecasters do not expect these dynamics to let up any time soon. In February, materials specialist Johnson Matthey wrote that “the deficit in the palladium market looks set to widen dramatically in 2019, with stricter emissions legislation forecast to stimulate double-digit rises in palladium demand from European and Chinese automakers”.
Liberum’s mining team agrees, and suggests “both visible and hidden stockpiles [of palladium] appear to be running out”, which could in turn widen the metal’s current $476 an ounce premium to platinum. “Speculative positioning is not particularly stretched and supply and demand shocks are more likely to result in a price upside in our view,” wrote analysts Ben Davis and Richard Knights last month.
“The market does look to have reached a point where available inventory is now extremely limited,” adds BMO Capital Markets commodity analyst Colin Hamilton. The current balance is also extremely unusual, by historical standards. According to precious metals consultancy Denver Gold, platinum has traded at an average of 2.65 times the value of palladium since 1990. But with supply unable to react, the next leg of the price rally will depend on the market’s elasticity, and the ability of auto-catalyst makers to substitute back to platinum.
One person who thinks the current market looks unsustainable is Mark Cutifani, who as chief executive of Anglo American (AAL) has oversight of one of the world’s largest palladium producers, Anglo American Platinum. “It is a bubble,” Mr Cutifani told a Financial Times resources conference last month, and suggested that “as new models get developed in the auto industry, adjustments will take place and maybe there will be some substitution”. However, Mr Cutifani expects palladium to remain elevated so long as the cost of switching is prohibitively expensive.
This could lead to new price records for palladium in the short term, although beyond 2019 the outlook is less clear. “In a market with very concentrated end use, a higher near-term price could mean more aggressive substitution and potentially a resultant medium-term demand void,” wrote Mr Hamilton in a note last month. “Commodity markets typically have a great ability to solve shortage situations.”
With platinum forecast to make up just under half of its platinum group metal (PGM) sales in 2019, Anglo American Platinum is well hedged if and when platinum does indeed come “roaring back”, as Mr Cutifani expects. In the short term, it is riding palladium’s wave, and 2018 results gave a small glimpse of widening cash profit margins. In fact, cash profits increased by 21 per cent to ZAR14.5bn (£791m), as high palladium and rhodium prices helped to offset higher inflation, ore depletion and a dip in platinum prices.
Applying their palladium price revisions to 2019 corporate earnings, analysts at BMO recently raised forecasts for Anglo American by 9 per cent, leading to a 20 per cent bump in the price target to £24 a share.
However, for most miners, palladium’s recent price spike should be seen against the recent fortunes for platinum, which often makes up the lion’s share of the so-called basket value of a miner’s PGMs. For the likes of Lonmin, the recent rally is effectively consolation for years of depressed earnings.
