Palladium Maple LeafFor the last few weeks, one of the lead stories in precious metals news has been the various lawsuits and international criminal investigations of the world banking cartel’s alleged gold market price fixing. However, several key stories regarding another important precious metal, namely palladium, have largely been pushed off the PM news radar.

“A picture is worth a thousand words.” This is certainly true in the case of palladium. Please see below the last two months palladium chart.

Palladium Nymex 2014

Courtesy of NYMEX.

As you can clearly see, in less than two months, palladium has moved from a low of $700 to a closing price Friday, March 28th, of $774, a gain of over 10.5%. Last year, palladium was by far the best performing of all the precious metals. What has been driving this upsurge in palladium and why does platinum’s little cousin stand an excellent chance of continuing to enjoy solid gains this year? The answer is fourfold: dwindling inventories , rising industrial and investor demand, giant labor unrest, and geopolitical tensions involving the world’s leading supplier, Russia.

1   Dwindling inventories As a rare precious metal, there are very few palladium producing regions in the world and even fewer financially viable deposits. Currently, Russia and South Africa, which are known as geopolitically high risk countries, account for almost 80% of global palladium mine production. Russia has seen its above ground palladium stores drop dramatically over the last several years. In 2010, Russia’s above ground palladium inventory was believed to be in excess of 1.2 million ounces. By the end of 2013, their stored inventory was reported to have dropped to only 200,000 ounces. Even more disturbing was the forecast by Johnson Matthey and other refiners that there was a very real chance that Russia’s stocks might become completely depleted by the early fall of 2014. Russia, much like China, is notoriously private in publishing their mine output and refined stores of precious metals numbers, but these Johnson Matthey forecasts are believed to be quite accurate.

Platinum is typically produced as a by-product from platinum mines in South Africa (more on this shortly) and the Norilsk Nickel mines in Russia, which are located north of the Arctic Circle amongst some of the harshest conditions in the world. Industrial output at Norilsk makes up more than 2% of Russia’s GDP. However, Norilsk is recognized as one of the most polluted industrial environments in the world and its palladium deposits are believed to be slowly diminishing in ore content.

2   Rising industrial and investor demandAuto catalysts today account for over two-thirds of world palladium demand. The world banking and credit crisis of 2008-2009 heavily damaged new car financing and sales. Palladium was a direct victim of the worldwide slump in new automobile consumption. Palladium suffered greatly, dropping nearly two-thirds of its value, from $600 to under $200 an ounce in just a year.

However, world auto sales, driven by the rising demand caused by the burgeoning Chinese middle class, have risen nearly 75% since 2009. The Chinese auto market has recovered surprisingly well, with 2013 sales up a very strong 14%, according to the Chinese Association of Automobile Manufacturers. The uptrend for auto sales in China will likely remain vigorous. There is a massive potential for new car demand in the western and central China. In the Chinese hinterlands, the car ownership rate is only 58 per 1,000 people (per the 2010 census) compared to a US average of 800 per 1,000 people. Moody’s Investor Service expects auto sales in China to increase in 2014 by 10% and the long term outlook for auto sales and corollary palladium consumption is second to none.

2012 and 2013 saw robust growth in the US auto market as well, with annualized sales of over fifteen million new cars. Helping this trend, European auto sales have finally bottomed out and the European market is expected to recover with forecasts for a 3% increase in 2014 sales.

    Water and air purification – Palladium has other industrial uses besides auto catalysts. Palladium is used in emission control equipment for factories and coal power electric plants as well as water purification. Palladium is used to clean contaminated ground water. Air and water pollution in China, India, and Southeast Asia are enormous problems that are precipitating health crises in these fast emerging industrial nations. Worldwide demand to clean up industrial pollution is on the rise. This can only benefit palladium and the platinum metals group.

    Investor demand – On the investment side, demand for palladium continues to rise. Investor interest in palladium exchange traded funds has grown from 800,000 ounces in the spring of 2009 to 2.2 million ounces by the close of 2013. With a new South African Palladium ETF set to be launched this year, consumption of palladium for speculative purposes has a very good chance to continue to expand.

Palladium ETF Holdings

3   Giant labor unrestSouth Africa, as a producer of nearly 40% of the world’s palladium, continues to undergo serious labor unrest in its mining sector. Ongoing mining strikes and violence have now plagued the South African mining industry for over a year, seriously hampering palladium production. On Friday, March 28th, hope for a settlement in South Africa’s prolonged platinum miner’s strike (palladium is a by-product of platinum mining) was dashed when the country’s largest mining union, the Association of Mine Workers and Construction Union (ACMU) boycotted a meeting chaired by South Africa’s deputy president. The ACMU has been on strike since January 23rd, demanding a monthly basic salary of $1,181 in US dollars. A series of talks aimed at ending the strike has so far failed and the prognosis is bleak.

South Africa’s Minerals Resource Minister, Susan Shabangu, pleaded for an end to the strike saying, “The situation is highly desperate…It’s not only hurting the workers, it’s hurting the country too.” So far, platinum/palladium mines have lost nearly $1 billion in revenue. Kevin Lings, an economist with the investment firm Stanlib, said, “Continuation of the strike could collapse the mining sector.”

Also plaguing the mining sector has been ongoing degradation of the mining and attendant electrical infrastructure. The endless strikes have crippled necessary repairs, making them more costly to complete.

Both sides of this strike have been sticking with intractable positions that have led to bloodshed, deaths, and implacable hostility amongst the participants. There is no forecast for an end to this situation. This very sad state of affairs, nevertheless, should serve as a bullish impetus to palladium prices.

4   Geopolitical tensions with RussiaThe very recent world crisis involving Russia’s annexation of the Crimea as a response NATO/US inspired coup in the Ukraine, is just in its infancy. This is not going away. Last week, the G8 voted to remove Russia from its inner circle. President Obama and our State Department are threatening Russia with sanctions but Russia holds a lot of cards here. They are the largest combined natural gas and oil producing country in the world and furnish all of Europe with a huge of percentage energy needs. The Obama Administration is considering banning purchases of Russian exports such as palladium so as to hurt Russia’s mining industry and economy. Russia could well respond by cutting off all western access to the nation’s palladium supply, thus substantially driving up prices for the precious metal. This would severely hurt all western and Chinese automobile manufacturers and the world economy in general.

Conclusion – There is an old adage, “When goods cannot cross borders, armies will.” We believe that the continued labor unrest in South African and the western instigated Ukrainian uprising on Russia’s western flank are not going to be ending any time soon. Reason is obviously not the dominant ingredient in either of these confrontations. Always remember that while greed and fear are the primary impetuses in driving market response, fear is always the greater stimulus. We expect palladium, along with other precious metals, to move higher in response to geopolitical, labor, and economic dissatisfaction. Adding palladium to your investment portfolio is a good idea.

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