Platinum, palladium prices surge in May

METALS COMMENTARY

The massive price swings in the platinum group metals (PGMs) in the second week of May and early the following week ensured that Johnson Matthey’s (JM) release of its annual PGM survey was even more keenly awaited than usual.

Interestingly, a surge in platinum prices in the second week of May meant that prices were already trading above the upper bound of JM’s predicted price range (US$1,250 per oz.) for the next six months. Despite providing a constructive fundamental picture for platinum, JM was cautious about the sustainability of prices at current levels. We would be more bullish on the upside potential in platinum.

Meanwhile, JM was more circumspect on palladium, where it believed demand could slow this year and estimated remaining Russian state stocks to be still substantial. Investor interest could drive palladium prices higher, but it also warned of significant downside risks for a small market lacking strong fundamentals.

The biggest wildcard for palladium, we think, is the amount of remaining Russian state stocks, which is undisclosed. Together with improvements on the demand side, lower than anticipated Russian sales (JM expects stocks still sufficient to support 1 million oz. per year over the next five to six years) would have strong positive implications on palladium, in our view.

Platinum

JM continued to paint a strong fundamental outlook for platinum. However, its 6-month price range of US$1,020-US$1,250 per oz. appears rather conservative to us, given that prices are already trading above the upper bound of this range and the market is expected to remain in deficit this year for the eighth consecutive year, according to JM.

Admittedly, the price correction early in the third week of May was an illustration of the large speculative involvement in the market and we do not rule out further near-term weakness given the recent sharp price gains. Nonetheless, we expect the market to remain well-supported at historically high levels. Even if prices do fall back below US$1,250 per oz., we see the potential for prices to breach, and possibly rise much higher than, this level over the coming months. In light of platinum’s constructive fundamentals, we would continue to recommend buying into price dips.

The platinum market was in a modest deficit of 70,000 oz. in 2005, up from the 50,000 oz. in 2004 but lower than the 120,000 oz. estimated by JM in its Interim Review 2005 published last November (though the 2004 figure was also revised down from 130,000 oz. to 50,000 oz.).

Supply grew slightly over 3% in 2005, largely due to mine expansions in South Africa, strong production by Norilsk Nickel and an 11.6% jump in autocatalyst scrap recovery. Against this, demand rose by roughly the same amount, though this masked a 9.5% increase in autocatalyst demand and a 9.3% fall in demand from the jewelry sector.

The European light vehicle sector remained the primary driver of autocatalyst demand, due to a combination of rising diesel vehicle production and tighter emissions standards. Despite the ongoing shift to palladium in gasoline vehicles, demand in North America rose slightly due to increased loadings in heavy duty diesel vehicles. Meanwhile, demand elsewhere in the world remained robust, particularly in China where demand from the auto sector surged by 14% as a result of higher light vehicle production and tightening emissions controls.

On the other hand, jewelry demand fell significantly in 2005 to below 2 million oz. for the first time since the mid-1990s, led by a sharp fall in demand from China. Rising prices continued to encourage substitution to more profitable white gold and palladium jewelry, and also resulted in inventory draw downs.

In terms of key issues and outlook for 2006, JM forecasts the market to remain in moderate deficit this year, with supply and demand expected to grow more strongly though there are uncertainties on both aspects. Supply growth will hinge critically on South African mine expansions, while the political situation in Zimbabwe has made it more difficult for any significant expansions.

Autocatalyst demand is expected to remain robust (almost certain to exceed 4 million oz., possibly by a significant margin, according to JM). In line with our views, JM noted the possibility of part substitution to palladium in diesel engines to occur this year but did not expect any significant impact on platinum demand, due to the time delays required for such changes.

The outlook for jewelry demand is more mixed. JM noted that demand from affluent consumers has been relatively resilient in the face of the high prices. Further, the de-stocking last year and early this year led to an upturn in demand from the Chinese jewelry manufacturers in mid-February and March. That said, jewelry demand is likely to weaken further should prices continue to strengthen.

Palladium

With palladium lagging behind platinum in the recent price rally, prices remain well in the US$260-US$420-per-oz. range predicted by JM over the coming six months. JM was more cautious on palladium, noting that it is possible for speculative buying to push prices “even further above the level that would appear justified by the level of demand from end users.”

In contrast to platinum, where it expected strong consumer demand to limit the downside in the event of a correction, JM highlighted substantial risks for palladium due to a lack of strong fundamental backing. We see sales from Russian stocks as the main swing factor for palladium. Smaller than expected sales, coupled with an improving demand picture present the key upside risks to palladium prices, in our view.

The palladium market remained in a large surplus of 1.35 million oz. last year, revised up from 650,000 oz. in the JM November report but still down from the 2.02 million oz. in 2004. The main factors behind this decline were smaller Russian supply, a sharp fall in North American output and a surge in jewelry demand. Norilsk Nickel, which disclosed its production numbers for the first time, produced around 3.13 million oz., all of which is understood by JM to have been sold last year.

Remaining sales from Russia were from the State Treasury stocks and included 439,000 oz. sales from Stillwater Mining (swc-n) (which received over 877,000 oz. from Norilsk Nickel when the latter acquired a majority shareholding in it).

Continuing the trend in recent years, exports from Russian state stocks rose significantly at the end of last year and in early 2006. JM estimated that over 1 million oz. of Russian state metal was sold into the market last year.

The largest fall in output was seen in North America, mainly due to a 43% decline in North American Palladium (pdl-t, pal-x) production. In contrast, supply from autocatalyst recovery rose by 19% last year as autocatalysts with higher palladium loadings from the mid-1990s entered the recycling chain.

The most notable trend in 2005 was another remarkable rise in jewelry demand after a surge (from 260,000 oz. to 930,000 oz.) in 2004. This was largely attributable to Chinese jewelry demand, which jumped by 71% on the back of better margins, rising popularity with consumers (rapid acceptance of Pd 990 jewelry which is 99% made up of palladium), and possibly some stock building. Apart from China, trade interest appeared to have also picked up in North America.

On the other hand, autocatalyst demand rose only marginally as strong demand in Asia (particularly in China where demand rose by 43%) was offset by weaker demand in the West. Despite ongoing substitution to palladium in gasoline engines, North American demand was adversely affected by thrifting and softer vehicle sales. However, the most significant decline was seen in Europe (-10%), due to falling gasoline vehicle sales and thrifting.

For 2006, JM believed that after three years of strong growth, palladium demand could slow. Autocatalyst demand will increase as thrifting is limited by the tightening emissions control
s and substitution in gasoline engines will boost demand, though the part substitution in diesel engines will not be significant this year, according to JM.

It was more cautious on jewelry demand, however, noting the possibility that the strong demand in China last year could have resulted in a build up in stocks. Supply is expected to be flat or lower as Stillwater has completed its stock sales during the first quarter of 2006, and much will depend on the expansion plans in South Africa. Without sales from Russian state stocks, palladium is likely to be in a deficit this year. However, according to JM’s estimates, the remaining Russian state inventory could still support sales of over 1 million oz. per year for at least the next four or five years.

— The preceding is an edited portion of Barclays Capital’s Commodities Research. It represents the opinions of the authors and does not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the website at www.barclayscapital.com