Joining the palladium party

The strongest-performing commodity has delivered stunning returns for investors. But will the good times continue?

By ·
4 Feb 2019

Summary: In a year marred by market volatility, this precious metal has been shining. 

Key take-out: Palladium investors have benefitted from a supply and demand mismatch. But will it continue?

 

Something unusual happened last week involving an extremely rare precious metal that’s hardly used for jewellery but has a huge place in the automotive sector.

The price of palladium, considered a sister to the better-known metal platinum, zoomed past gold for the first time in 16 years, on its way to an all-time high above US$1,400 an ounce.

For those lucky enough to pick the palladium price trend, even as recently as three months ago, the returns have been exceptional. The ETF Securities Physical Palladium exchange traded fund, one of the only access points into palladium on the Australian Securities Exchange, has returned 18.5 per cent over the past three months, and 32.1 per cent over the year.

Another fund, the ETF Securities Physical PM Basket fund, also contains palladium bullion, along with gold, silver and platinum, that’s stored in a London vault owned by HSBC. The fund has returned 11.7 per cent over the past three months, and 11.41 per cent over the year.

Zimplats Holdings, a company mining palladium in Zimbabwe, is the only producer of palladium ore that’s listed on the ASX, although its price run has been far more modest than that of the precious metal funds.

Palladium ore has been the best-performing commodity for the last two years, with its price having more than doubled from the US$690 it was fetching back in 2015. Much of that gain has happened in more recent times however, with the palladium spot price having risen 70 per cent since last August, and about 16 per cent since the start of the year.

So, what’s actually driving palladium? The short answer is cars, because palladium is one of the essential ingredients inside the catalytic converters of vehicles with combustion engines that are used to reduce their exhaust emissions. It’s also used in electronics, dentistry and some medical devices.

And, it’s the old story of supply and demand in motion. Russia and South Africa are by far the biggest producers of palladium, followed by Canada and the United States. But global supply is very limited and, while the production of electric vehicles is accelerating, it’s the rapid switch from diesel to petrol engines that’s sparking up palladium.

That switch reflects the big move by European governments to the “Euro standard”, which over time will result in older, higher-polluting diesel vehicles being banned across the continent. In fact, bans on “dirty” vehicles have already come into effect in Brussels and Hamburg, and more big European cities will soon follow suit.

The massive vehicle emissions scandal involving Volkswagen in 2015, which resulted in more than $30 billion of fines, has also spurred a huge consumer shift away from diesel cars to petrol vehicles and hybrids.

Kris Walesby, head of ETF Securities Australia, says palladium has been the big investment success story for precious metals, and will likely continue to be for some time due to structural shifts in global emissions protocols.

“It’s interesting, because a lot of Australians don’t look at precious metals, when in fact some of the story of precious metals is very compelling,” Walesby says.

“This trend in palladium is all about catalytic converters – we’re talking about petrol cars – and the consistently growing demand for combustion-based cars because electric vehicles are not yet offsetting that demand. It’s a big structural theme, where the best way to play it is probably not at a company level but actually with the metal itself.”

A Reuters poll taken last week of 29 metals analysts found most are expecting the highest-ever year for palladium prices, with an average price forecast of US$1,200 an ounce in 2019, followed by a slight pullback to an average price of US$1,150 in 2020 – up from US$1,027 last year.

Cuts in automotive tariffs from China have boosted demand for the metal, with China aiming to introduce policies to boost domestic spending on items such as cars, which in turn will bolster demand for palladium.

“Palladium, even if it corrects, and it probably will for a period, will continue to perform well for some time,” Walesby says. “That structural shift is still going to continue for probably decades because there’s not enough electrical vehicle demand yet to offset an increasing need and ability to buy cars globally, not just in developed world, but mainly in the developing world.”

Ultimately, the trajectory for palladium will continue to come down to how much of the metal can be produced, with output from mines in Russia and South Africa having been patchy over time. In South Africa in particular, industrial disputes have been a constant disruptor to global palladium supply.

The latest price rally also reflects growing geopolitical tensions between the United States and major palladium supplier Russia, heightening concerns of a potential supply disruption down the track.

Industry consultancy Metals Focus noted in a recent report that it expects palladium supply is headed for the second-highest level this decade, but that supply won’t be able to meet demand. Automotive companies are expected to require a record 8.5 million ounces of palladium to make catalytic converters in exhaust systems, but supply will fall short by 1.2 million ounces.

That’s good for the palladium price, but there are economic and industrial factors that could spoil the party.

For one, any slowdown in economic growth in large emerging markets such as China and India, let alone in the US and Europe, will certainly dent automotive sales and the need to produce more catalytic converters. That, in turn, will reduce demand for palladium.

On the industrial side, given the relative scarcity of palladium as a mined product, manufacturers are looking at cheaper and more abundant alternatives they can use to reduce emissions, including synthetics and even platinum.

At an average price of US$856 an ounce this year, platinum is certainly much cheaper than palladium at this point. That’s already on the radar of metals analysts, and speculators won’t be too far behind.


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