Platinum has already surged this year, reaching levels not seen since 1980. Indeed, platinum has been the only real challenger to nickel for the title of “star metal,” which is fitting given it’s the only precious metal backed by a tight physical market and genuinely supportive commodity fundamentals.
The precious metal has benefited from all the key commodity themes — Chinese growth (primarily in jewelry), the weakening U.S. dollar (particularly against the rand, threatening South African mine expansions), strong industrial demand (the resilient auto sector) and supply constraints (at least in term of supply growth failing to match demand growth). In addition to all this is the general investor appetite for commodities as a whole.
The commodity fundamentals of the platinum market are easily the most constructive of the precious metals, and, notwithstanding the occasional bout of profit-taking, we expect prices to challenge record multi-year peaks. However, virtually all “good news” is in the price, and we see the risk-reward profile for platinum increasingly difficult to justify for investors. We see the market correcting as demand slows (price sensitivity is not dead, but takes time in both the auto and jewelry segments) and the outlook for supply improves (as the rand retraces).
Platinum demand was firmer in 2003, with strength in the autocatalyst segment more than offsetting the first drop in Chinese jewelry demand in a decade. Demand from the autocatalyst segment has been assisted by the resilience of vehicle sales in the U.S., a recovery in Japanese sales, and the ever-increasing market share of diesel engines in Europe (up from 40.4% in 2002 to 44%). In 2004, we are expecting underlying consumption of platinum in autocatalysts to remain firm, with sales at least remaining at current levels.
However, early last year many automakers used the lower U.S. dollar borrowing costs, relatively low spot price (around US$600 per oz.), strong fundamentals and an attractive backwardation to buy a significant proportion of their platinum requirements in 2004 (and indeed, in some cases, beyond that).
Hence, we are wary that underlying consumption of platinum in autocatalysts this year will not necessarily flow through to the equivalent level of buying, especially with prices at, let alone above, US$800 per oz.
We expect industrial demand to increase, given accelerating economic growth. Demand from the chemical industry has been stagnant, dampened by the closure of gas refinery capacity in the U.S., but some recovery should be evident in 2004. Demand from the electronics segment will also improve, with a boost also from fuel-cell development programs.
We expect Chinese jewelry demand to recover, albeit modestly, from last year’s SARS- and price-related drop. The other issue affecting demand in 2003 was a squeeze in the margins of jewelers. The ability of jewelers to push through higher retail prices in 2004 will be an important test of the price sensitivity of the market.
In recent months, underlying consumption of platinum jewelry has slowed only modestly, owing to higher prices, with physical traders regularly buying dips in the price. Affluent urban consumers appear undaunted by higher platinum prices; however, alternative materials such as white gold are challenging lower-end demand. The recent outbreak of the bird flu virus is also a threat.
Offsetting higher prices is the ability now to buy platinum on the Shanghai Gold Exchange, where it is sold without the imposition of import duties or value-added tax.
Concern over the supply of platinum is an issue that has encouraged further investor interest in platinum. The issue, unlike in the base metals, is not a lack of growth (most producers have ambitious expansions plans). However, investors have been encouraged by the resilience of impressive demand growth rates and downward revisions in expansion plans, which increasingly appear to suggest that the platinum market will remain in a balanced to deficit market.
The key to sentiment has been announcements from the world’s largest producer,
Scrap recoveries, in comparison, continue to accelerate, though some slowdown is now expected, given the change in platinum group metals loadings that occurred after 1996.
President Bush, in his State of the Union address in late January, announced a long-term initiative to reduce U.S. dependence on foreign oil by developing hydrogen-powered fuel cells to run cars, trucks, homes and businesses. The U.S. administration wants to have the hydrogen cars on the market and available to consumers at an affordable price near the end of the next decade.
This announcement prompted further investor interest in platinum, for it strengthened the metal’s outlook, despite the fact that fuel cells remain a long-term hope. In early February, the U.S. said it will add US$69 million to a research budget of US$228 million for 2005 to develop cars that run on hydrogen fuel and the service stations to support them.
The U.S. Department of Energy commissioned a report by TIAX LLC to investigate the long-term availability and price stability of platinum given anticipated demand from fuel-cell vehicles.
The report, publicly released in January, found that the availability at a stable price should be no barrier to fuel-cell commercialization — despite projections that platinum demand will grow at 3-6 times the levels seen between 1960 and 2000 if fuel cells are commercially available.
The report noted that the price of platinum is likely to rise in the short term (the study looked at the outlook from 2005) in response to, or perhaps in anticipation of, increasing fuel-cell demand.
Ultimately, the report concluded that the price would return to its long-term mean of US$550 per oz. once supply catches up to demand.
Overall, the balance of the report appears to assume that the trend of the platinum market is for prices to spike and then correct back to the long-term mean.
It will be interesting to see whether more investment funds will now see this as a long-term opportunity too good to miss.
Palladium
Palladium has been the laggard of the precious metals complex, and this underperformance reflects poor consumer demand. Inventory levels have fallen but are still significant, and there are growing supplies of palladium from both new mine projects, particularly in South Africa, and scrap.
However, palladium has found good support around US$190 per oz., with investors seeing little downside on the basis of an expected improvement in physical demand due partly to economic growth and partly to assumed substitution from other materials, particularly platinum. Furthermore, investor interest in commodities has buoyed all metal markets. On the other hand, upwards progress towards US$250 per oz. will be heavy going, owing to the potential for producer selling.
That said, we are wary of the potential surprise to the upside that could be fuelled by investors buying in anticipation of a rebound in future demand. Indeed, the mere fact that palladium has lagged behind other commodities, particularly the other precious metals, will ensure that it receives investor interest. In contrast to the other precious metals, we see modest downside risk from current levels, but offsetting this is that the likely upside is also constrained.
Palladium has been a strong performer since late 2003, defying predictions of a collapse below US$100 per oz. Buying interest in palladium returned as prices fell below US$150 per oz. and have recovered back above US$200 per oz. At the lower levels, there were signs of reduced producer selling and, importantly, of some consumer interest. However, the key for palladium was the return of fund-buying interest.
For a fundamental justification, funds were arguably attracted because much of the “bad news” was “in the price” in terms of substitution by platinum in autocatalysts and by nickel in multi-layer ceramic capacitors. Another factor was increased scrap and mine supply (particularly from South Africa). More than this, funds were encouraged that the surge in platinum would result in substitution back to palladium, while the strength of the rand threatens the new, palladium-rich, mine projects in South Africa.
However, we suspect funds were simply searching for opportunities to invest in commodities but found that most had already risen appreciably. Hence, funds were attracted to palladium for a better risk-reward proposition, given that prices had already fallen from more than US$1,000 per oz. and had found support towards the historical average of around US$150 per oz.
Significantly, it does appear that many funds have invested in palladium with a long-term outlook and so have steadily increased their positions in 2004 despite steady selling pressure from producers.
Such dominance by funds carries with it the threat of a sharp correction, but at this stage, with these positions appearing to be in strong hands, we do not believe mass long liquidation is imminent.
Last year saw something of a recovery in palladium demand, though this was largely due to reduced use of existing inventories rather than any impressive rebound in underlying consumption.
Global auto sales are likely to grow modestly in 2004, and there will be a flow-through to increased palladium consumption. However, this will be dampened somewhat by the continuing existence of inventories, particularly in North America, and by the increasing market share of diesel engines in Europe. Higher loadings in Japan should support demand, but continued spending cutbacks in other markets are likely to offset growth in China and India. Substitution back into palladium is limited by continuing concerns about stability of supply from Russia and the time delays inherent in designing, approving and implementing new specifications for automotive components.
There will need to be concerted action from automakers either in terms of buying approaches or technology if there is to be a major substitution impact from palladium to platinum in the foreseeable future.
Buying of palladium for the electronics segment did recover impressively in 2003, almost entirely as a result of reduced use of existing inventories. But underlying consumption continues to be limited by spending cutbacks, miniaturization and substitution to nickel-based MLCCs.
There has been improvement in the demand for dental alloys, and this should continue, with palladium benefiting from the high price of gold and as increasingly aged populations result in growth in this segment generally.
Palladium supply also recovered in 2003, largely as a result of the full return of
Norilsk has been a regular seller into the market in recent months, and this is likely to continue. However, Norilsk has expressed a commitment to moving to long-term contracts with consumers. The major development last year for Norilsk was its purchase of
The development of projects mining UG2 ore in South Africa can be expected to boost output, as these mines have a higher palladium content, especially on the Eastern Bushveld. However, the strength of the rand (and a low palladium price) has delayed these projects.
Supply from Zimbabwe continues to expand in line with increasing output at Mimosa and Ngezi. However, supply was lower in North America in 2003 as a result of the combined impact of lower output from Stillwater and less byproduct output from
Recovery of palladium from scrap is accelerating, and this is a reflection of the higher palladium loadings in autocatalysts from the mid-1990s that are now being recycled. This cycle can be expected to continue. There is some uncertainty over the price sensitivity of scrap sales, and the next few months could be quite revealing on that front.
Given all this, it should come as no surprise that there is no scarcity of palladium. Option volatility was being bid higher during the initial stage of the recovery but has softened recently. Lease rates, though slightly higher now, remain low on a historical basis.
— The opinions presented are the authors’ and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the authors at kevin.norrish@barcap.com and ingrid.sternby@barcap.com
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