Perfect Storm for Platinum and Palladium

Better than Silver and Gold

Written by Jimmy Mengel
Posted September 23, 2013

Don't get me wrong; I like gold.

And I love silver.

But right now, there are two metals that look more attractive than both of these more "conventional" precious metals...

The platinum group metals (PGMs) are the smallest of all the precious metals markets — so small, in fact, that many people don't even consider platinum and palladium when they invest in precious metals. PGMs are “hidden metals” used in the automobile, electronics, dental, and chemical industries.  

If I were to buy any precious metals right now, it would be PGMs.

Why? Well, frankly, gold is just too tough to time for short- to medium-term investments...

Now, you can certainly buy the dips in gold and silver, and hold them until the entire world comes apart at the seams.

However, if you want to bank gains more than once, platinum and palladium can do that for you.

And both metals offer all the attributes that gold bullion has historically — and more.

It's a medium of exchange, but PGMs work simultaneously as an asset... and they're becoming increasingly valued as an industrial metal, which makes the supply fundamentals much easier to understand.

At current prices, the mining industry doesn't earn back the cost of capital. So supply has fallen by 19% over six years.

The supply demand fundamentals are better than the rest of the precious metals.

Platinum and palladium supply come from just three places, by and large: South Africa, Russia, and Zimbabwe. 

Each of those locations poses unique characteristics that impact the price of the metals.

We'll be focusing on South Africa today, since South Africa is the top producer of platinum and the second largest palladium producer: 70% of platinum and palladium come from the region. 

Violent wage disputes have disrupted mining since last year, when labor strikes came to a horrifyingly violent end. Police fired on thousands of striking miners, killing 34 and sending platinum producers into panic mode.

Platinum prices jumped 15% almost overnight after the crackdown.

The miners are demanding better wages in part because mining platinum is a difficult and dangerous job. Here's how it goes down:

Vast quantities of molten rock from the earth's mantle were brought to surface through long vertical cracks in the earth's crust, huge intrusions created the geological intrusion known as the Bushveld Igneous Complex. Those metal veins are very thin.

That makes it very difficult to do highly mechanized mining, which generates a lot of waste ore and a very small amount of platinum and palladium.

Consequently, platinum group metals miners do not rely upon mechanization, like trucks and other mining equipment. They dig the metal out by hand while lying on their backs in very cramped and hot conditions.

It is impossible to get mechanized equipment into these narrow mine shafts. This method of mining is very expensive because of the amount of manual labor needed.

Due to the laborious process of extracting the metals, more than half of South African miners aren't making a dime producing platinum.

While the price right now is hovering around the mid-$1,400s, the cost of producing it is about $1,800 an ounce. Some easy math will tell you that prices will need to rise, or mines are going to continue to shut down or stall.

These fundamentals have led Barclays to predict a 1.6% drop this year — the lowest output since 2000.

And while supply is dropping, demand is rising... 

More than Just "Bling"

While platinum is well-known for use in expensive “bling” and record-setting rock and roll records, platinum and palladium are primarily used for vehicle emissions controls.

In fact, 46% of the platinum mined is used for catalytic converters in cars.

This is where palladium is actually outshining platinum: Palladium has been slowly replacing platinum as a lower-cost material for catalytic converters for the past two decades, since it can basically perform the same function as platinum at 25% less cost.

And cars are finally selling again: 

  • North America production has risen five years in a row, only the second time since World War II. Some analysts are predicting we may surpass over 16.1 million deliveries of new cars and trucks next year — within arm's reach of the 17.4 million record.

  • China's automotive market is also on the rise, with production hitting all-time highs. Some analysts are predicting 10%, 20%, and 30% increases year after year. All those extra cars on the road mean China's atrocious pollution problems will need to be addressed with stricter emissions standards. Palladium and platinum will be crucial in combating pollution in this country.

  • Even in Europe, where auto sales have been nothing short of abysmal during the Eurozone crisis, are expected to jump 3% next year. 

Every one of these autos requires either platinum or palladium.

What may be better news is that auto sales are rising despite the weak global economy. If things improve, even at a slight pace, production will only increase.

Increased auto production will set these metals up for a spectacular rise over the next few years.

A Perfect Storm 

Between the supply constraints and the rising demand, it looks like now may be the time for platinum and palladium to hoist themselves into the thick of the precious metals investment discussion. And in fact, they may already be pulling away...

“It's pretty close to a perfect storm in the palladium space,” said David Franklin, market strategist at Sprott Asset Management.

But as we discussed, the South African volatility makes it risky to put your money on the miners themselves.

Since they aren't currently making money, that also means that they aren't exploring and developing new mines; and the mines they currently operate are falling into disrepair. These obstacles will only contribute to supply issues down the road.

That's why — as with silver and gold — we're more bullish on the metal itself than the miners...

If you don't want pounds of platinum and palladium bars lying around your house, than you best bets are physical platinum and palladium ETFs. The two biggest ones are ETFS Physical Platinum Shares (NYSE: PPLT) and ETFS Physical Palladium Shares (NYSE: PALL).

If you're a Crow's Nest reader, you'll be hearing a lot more about about a brand-new way to play them both at the same time in your next issue. So stay tuned...


Jimmy Mengel

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Jimmy is a managing editor for Outsider Club and the investment director of several personal finance advisories, The Crow's Nest, and The Adventure Capitalist For more on Jimmy, check out his editor's page.

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