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Metals: Still Palladium’s Moment to Shine

MRP added Long Palladium as a theme on October 9, 2017, on the basis that improving demand and supply fundamentals were setting the stage for a multi-year supply deficit that would push the metal’s price higher. But, after delivering the best return among major raw materials in 2017, palladium has struggled this year. Palladium’s spot price and the palladium ETF (PALL), which we are using to track the theme, are both down about 10% year-to-date, with several ups and downs between the beginning of the year and today. Overall, the theme is up 6% since the October 9 launch, although in mid-January it was about up almost 20%.

The decline is largely due to external macro factors rather than fundamental issues.

While there were concerns at the beginning of 2018 that last year’s 55% surge had sent prices up too fast, much of the volatility we’ve been seeing this year has had to do with headlines related to US trade and sanctions policies, as well as technicalities in the trading market.

Palladium, like platinum, is used to cut down carbon monoxide emissions from vehicle engines. Indeed, 80% of palladium demand comes from its use in catalytic converters for automobiles. After the US decided to impose a 25% tariff on steel imports and a 10% tariff on aluminum imports in March, many feared the tariffs would end up stifling demand for cars, which would in turn reduce demand for palladium-based catalytic converters. But, even though cars require tons of steel, the downstream impact on car prices might not be as significant as initially expected. A 20% increase in the price of steel, for example, would raise the price of a $30,000 car by just $100-$200, according to industry insiders.

It seems, fears of a major drop in demand may have been premature. In fact, palladium consumption in devices used to clean up exhaust fumes is forecast to rise to a record in 2018, as appetite for gasoline vehicles increases. While platinum is used in diesel cars, palladium is used in gasoline-based generators. Tougher pollution control rules in China, and the weakening appeal of diesel cars in Europe have benefited gasoline-powered cars because they tend to pollute less than diesel. Several cities and provinces in China are expected to implement new anti-pollution regulations as early as next year, which would result in a double-digit increase in palladium consumption on Chinese cars.

Meanwhile, the news flow around Russian sanctions has also complicated the outlook for palladium this year, creating a whipsaw effect in the market. About 40% of global palladium supply comes from Russian mines, so any disruption to those shipments would be significant for a commodity that’s already on short supply. When the U.S. threatened to slap additional sanctions on Russia following a chemical gas attack in Syria allegedly orchestrated by the Assad regime, which Vladimir Putin supports, Palladium prices surged on speculation that Russian producer MMC Norilsk might show up on the target list. Before long, the US treasury softened its stance, causing palladium prices to plunge, as concerns about supply disruptions eased.

Compounding matters further, a popular trading strategy that allows hedge fund managers to capitalize on a supply shortage that’s driving consumers of the metal to the lease market has put additional pressure on the palladium ETF (PALL). The hedge funds’ strategy entails selling their long position in a palladium-backed ETF, taking physical ownership of palladium, and leasing it out to whomever needs it. Borrowers pay holders of palladium a lease rate of 6% to use the metal for a week.

This lucrative business of leasing palladium has prompted millions of dollars in withdrawals from ETFs backed by the metal. Holdings in ETFs are near the lowest since 2009, while inventories tracked by the New York Mercantile Exchange have shrunk by more than a fifth in the past six months.

Despite these distractions and the volatility, palladium prices have shown strong resilience. The metal, which traded around $1,100 per ounce at year-end, slipped to about $900 / oz in April, before rebounding to its current price of $998. This resilience reflects the fundamental supply deficit that exists as a result of production trailing demand for years. Consumption outstripped production by about 110.6 metric tons in 2017. Analysts expect further deficits this year and in the future, which compels us to maintain our bullish view on palladium.

Following is our October 2017 report titled: PALLADIUM’S MOMENT TO SHINE – MRP Adds Long Palladium as a New Investment Theme

Investors can gain exposure to the theme via the Palladium ETF (PALL).

 

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