If I asked you why I’m bullish on platinum and palladium, you’d likely point to the strikes in South Africa, the world’s largest producer of platinum. Or maybe the geopolitical conflicts with Russia, the largest supplier of palladium. Maybe even because some technical analysts say the palladium price has “broken out” of its trading range.
These are all valid points—but they’re reasons why a trader might be bullish. When the strikes end, or Russia ends its aggression, or short-term price momentum eases, they’ll sell.
And that will be a mistake.
Because underneath the headlines lies an irreparable situation with the platinum group metals (PGM) market, one that will last at least several years and probably more like a decade. These markets are teetering on the edge of a supply crunch, one more perilous than many investors realize. As the issues I outline below play out, prices will be forced higher—which suggests you may want to diversify into the “other” precious metals now.
The basic problem is that supply is in a structural deficit. It won’t be resolved when the strikes end or Russia simmers down. Here are the reasons why…
The centerpiece issue of the striking workers in South Africa is wages. In spite of company executives offering to double wages over the next five years, workers remain on the picket line.
Regardless of the final pay package, wages will clearly be higher. And worker pay is one of the biggest costs of production. The problem is, the two largest South African producers (Anglo American and Impala), which supply 69% of the world’s platinum, are already operating at a loss.
Once the strike settles, costs will rise further. Throw in ongoing electricity problems, high regulations, and past labor agreements, and there’s virtually no chance costs will come down.
This dilemma means that platinum prices would need to move higher for production to be maintained anywhere near “normal” levels. Morgan Stanley predicts it will take at least four years for that to occur.
And if the metal price doesn’t rise? Companies will have no choice but to curtail production, making the supply crunch worse.
One reason the platinum price has been muted during the work stoppage is because there have been adequate stockpiles. But those are getting low.
Impala, the second-largest platinum producer, said the company is now supplying customers from its inventories.
Further, since producers can’t currently meet demand, customers have to obtain metal from other sources, including buying it on the open market.
As inventories decline, supply from producing companies will need to make up the shortfall—and they’ll have little ability to do that.
Companies are already strategizing how to deal with the fallout from the worst work stoppage since the end of apartheid in 1994…
Amplats said it might sell its struggling Rustenburg operations. Even if it finds a buyer, the new operator will inherit the same problems.
Some companies have announced they may shut down individual shafts. This causes a future problem because some of these mines are a couple miles deep and would require a lot of money to bring back online—which they may balk at doing with costs already so high.
It’s not being advertised, but a worker settlement will almost certainly result in layoffs since some form of restructuring will be required. This could trigger renewed strikes and set in motion a vicious cycle that further degrades production and makes labor issues insurmountable.
Palladium demand is expected to rise more than platinum, so Russia’s status is important, since it provides 42% of global supply.
But it’s also in trouble…
Ore grades at its major mines, including the Norilsk mines, are reported to be in decline.
New mines in Russia will take as long as 10 years to come online. This means that at least for the rest of this decade, Russian production will decline. This stands in stark contrast to the demand for palladium, which has grown 35.8% since 2004.
Russia’s aboveground stockpile of palladium appears to have dwindled to fragile levels. The precise amount of the country’s reserves is a state secret, but analysts estimate stockpiles were 27-30 million ounces in 1990.
Take a look at reserve sales today:
Many analysts believe that since reserve sales have shrunk, Russia has sold almost all its inventory. To whatever extent this is true, it paints a sobering picture for the world’s largest supplier of palladium—and is very bullish for its price.
Most readers know the greatest use of PGM is in auto catalysts, which help reduce pollution. Platinum is the primary metal used for this purpose and has no widely used substitute—except palladium.
But that market is already upside down.
Palladium is a cheaper metal, but replacing it with platinum on a large scale would worsen the supply deficit.
As for platinum, auto-parts manufacturers will use more metal than is mined for the third straight year. Switzerland’s imports in March fell to their lowest level in over five years.
Some investors may shy away from PGM because they believe demand will decline if the economy enters a recession. That would be true if it happens, but increasing car sales in Asia could negate the effects of declining sales in weakening Western economies.
For example, China is now the largest automaker in the world. According to IHS Global, auto sales in China are projected to grow 5% annually over the next three years. PricewaterhouseCoopers forecasts that sales of automobiles and light trucks in China will double by 2019. That’s a lot of catalytic converters. This trend largely applies to other Asian countries as well. It’s important to think globally when considering demand.
In the big picture, though, supply is likely to fall much further than demand.
Investment demand for platinum rose 9.1% last year. The increase comes largely from the new South African ETF, NewPlat. At the end of April, all platinum ETFs held nearly 2,600 tonnes—a huge amount when you consider it was zero as recently as 2007.
Palladium investment fell 84% last year. However, year-to-date demand is up sharply due to the launch of two South African palladium ETFs, pushing global holdings to record levels. And like platinum, there was no investment demand for palladium seven years ago.
Growing investment demand adds to the deficit of these metals.
Add it all up and the message is clear: by any reasonable measure, the supply problems for the PGM market cannot be fixed in the foreseeable future. We have a rare opportunity to invest in metals that are at the beginning of a potential 10-year bull market.
Platinum and palladium prices may drop when the strikes end, but if so, that will be a buying opportunity. This market is so tenuous, though, that an announcement of employees returning to work may be too little, too late.
We thus wouldn’t wait to start buying.
GFMS says the palladium price will hit $930 before year-end. But that will just be the beginning, as the forces outlined above could easily push prices to double over the next few years.
We strongly recommend adding platinum and palladium to your Hard Assets Alliance account now.
Jeff Clark is editor of BIG GOLD, and a regular contributor to the Hard Assets Alliance.
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