Fools platinum?

According to The World Platinum Investment Council (WPIC) now is a good time to invest in platinum…well I guess they would say that. So what is the reason for why the WPIC (backed by platinum miners to promote the use of platinum) is so positive on the outlook for the metal right now?

As the FT reports “This is only the fourth period in … 40 years where platinum is at a sustained discount to gold. Investors are increasingly telling us that they view this divergence from historical norms as significant and temporary,” the council said.

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Platinum prices are up over 19% since the start of 2016 with investors taking a shine to platinum and other precious metals as interest rates moved towards or below zero across much of the world and geopolitical concerns (Brexit, Trump etc.) escalated. While platinum prices have been supported by stronger investment demand they remain some 20%-25% below the price of gold (a discount which has been in place since November 2015). The main reason for the discount to gold being the emissions scandal involving Volkswagen.

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Uncertainty around demand for platinum has spiraled since the scandal, almost a year ago. If demand for diesel vehicles fell then so could demand for the platinum that is used to make the catalytic converter in diesel cars (about 40% of platinum demand comes from vehicles). 

Although the longer term outlook for platinum looks murky (more on that in a minute), the next couple years at least look positive. First, the decline in the relative price of diesel versus petrol has increased demand for diesel cars. Second, Europe’s new emissions rules for 2017 will require more platinum use in diesel catalysts than currently takes place. Third, tighter regulations on emissions are spreading to off-road vehicles and power generators – trends which could further support increased demand for platinum. According to a recent presentation by Johnson Matthey automotive demand for platinum could rise 2% in 2016.2016-09-10_2014

Further out towards 2020 things get a lot more challenging. Last week Renault voiced concerns that tougher standards and testing methods would increase technology costs to the point where diesel is forced out of the market. The car manufacturer expects diesel to disappear from most of its European cars. Total diesel car sales will plummet to 9% of the European market in 2030 from 52% today, AlixPartners predicted in June, with the decline accelerating after 2020.

I’ve talked about demand, but what about the supply side? Platinum mine supply is forecast to 3% this year according to Johnson Matthey with South Africa, the largest producer set to see declines. Around 80% of platinum mines in South Africa are thought to be unprofitable according to The Chamber of Mines. This financial pressure has resulted in thousands of jobs being cut, mines being sold and unprofitable mines being shutdown. In turn this has raised the risk of labour disputes, that until recently have had limited impact on prices. Meanwhile, the sharp drop in the South African rand has encouraged miners to sell more platinum abroad.2016-09-11_0557

In recent years, a large stockpile of platinum has also contributed to the muted price response to production problems. However, according to the WPIC above ground stocks are forecast to fall from 4.1 million oz at the end of 2012 to below 1.9 million oz at the end of 2016.

Recycling, by far the cheapest way to access platinum, has been boosted by the rebound in steel prices which has improved the economics of recovering platinum from used catalytic converters and boosted supply. According to Regarding Capital Management in Cape Town, South Africa recycling will probably be the biggest and lowest-cost producer of platinum in the next year or two. As stockpiles dwindle, recycling may become the new source of platinum that acts as a buffer to future imbalances in the market.

Its worth looking back to 2007/08 to see what caused platinum prices to spike in to over $2000 per oz to understand whether the same forces could be in play now.

  • Car manufacturers reacted to the relative cheapness of platinum versus palladium earlier in the decade to reconfigure vehicles to use more platinum, boosting demand for the metal. The rising share of diesel cars in the European market helped support demand.
  • Investment demand climbed after the launch of two new platinum based exchange traded funds in Europe in the first half of 2017.
  • Platinum supplies fell over 4% due to problems in South Africa (geological problems, industrial disputes, a power supply crisis and flooding in 2008).

In contrast to the bullish factors at play in the run-up to the 2008 boom there appear to be no such factors lurking around the corner with platinum. Remember, even though there is a big discount, from an historical perspective versus gold it doesn’t necessarily follow that platinum prices are primed to rise above gold to correct this. Gold prices could fall instead. And with interest rates potentially increasing in the US as early as this month, gold prices could fall soon.

Related article: Which commodities are most affected by lower oil prices?

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Why I am a convert to technical analysis of commodity markets

“Fundamentalists that don’t pay attention to the charts are like a doctor who says he’s not going to take a patient’s temperature.” – Bruce Kovner

Up until relatively recently I was like that doctor who never checked the patients temperature.

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I shuddered at the thought of names such as ‘Inverse Head and Shoulders’, ‘Double Bottoms’ and ‘Saucers’. I disparaged (albeit privately) the notion that there were resistance and support levels from several years ago that were still relevant today. I winced whenever I heard news outlets discussing the short covering of hedge funds for the reason why one or another commodity prices had rebounded last week.

Perhaps the reason for my uneasiness is that I was being too rational, believing that fundamentals were the ultimate driver of commodity prices, both in the short and the long term. Surely some apparently arbitrary historical chart patterns could not provide the basis for an analysis of future commodity prices?

In my book I devoted one chapter to technical trading, and in it I questioned whether technical trading was compatible with the random walk hypothesis, i.e. that the past movement of any financial asset (be it stocks or commodities) are of absolutely no help in predicting future movements. We all know that even if a coin comes up heads ten times in a row, the probability of heads on the next throw is still fifty–fifty. Likewise, the random walk hypothesis says that even if a commodity price has risen for the last ten days, it tells you nothing about what it will do tomorrow.

Similarly I questioned whether seasonal tendencies in commodity prices were really any help. Surely the existence of such a pattern (at least where the price swing is substantial) would imply that the market is so inefficient that some participants would be able to profit at the expense of others simply by following the calendar.

I now understand that the reality is different and I’m happy to confess that I believe technical analysis is an important part of understanding why commodity prices are where they are now and where they could go in the future.

So what has changed my view?

Well partly its a recognition that while fundamentals play a large role, the disconnect between data availability (whether that is economic or commodity supply related), the quality of that data and then the time by which fundamentals actually have any impact on price is just too large to play the defining role in short term price formation.

Technical analysts argue that all the market information is available in just one element: the price. The fact that so many commodity traders (whether futures or physcial trading) use technical analysis, even in part suggests that it works, if at least part of the time. But why should it? In The Sugar Casino Jonathan Kingsman argues that it is in part belief, but that that argument can only go so far.

In a way, the answer to that question may be circular. It is possible that technical analysis works because people believe it does. The power of positive thinking has long been demonstrated and it sometimes seems that just believing in something can make it happen. However, the power of positive thinking has its limits. Many people believe that aliens already live on our planet but that does not mean they do.

However, Kingsman suggests a better answer may be found in the nature of human psychology and behaviour. In the book he argues that human beings are irrational and emotional and that no matter how well you think you know someone, it is difficult to predict how that person will behave in response to a particular event. However, if you put a number of individuals together, human behaviour becomes repeatable and predictable.

…if human behaviour does not change, it must repeat itself. And if it repeats itself, it must be predictable. To put it another way, consciously or subconsciously, humans use their experiences of past events to show them how to react to current ones. If you put enough human beings and enough of those experiences together you get a pattern. If the sample size is big enough you may be able predict the future just by looking at that pattern.

Given an acceptance that technical analysis is at least partly responsible for commodity price movements, what is the correct mix of fundamental vs technical analysis?

I think that’s a fluid answer depending on the market and the role that speculation plays (one could argue that natural gas is more closely linked to underlying fundamentals than gold, given the former is much more linked to physical demand), the amount, frequency and quality of data (sparseness of data perhaps opening a void for technical analysis) and the degree of uncertainty at different periods of time (political, economic uncertainty etc.).

Expect me to include more technical analysis, supplementing fundamental analysis in future blog posts.

 

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Corn on the cusp

Corn prices have slumped by almost a quarter since the end of June to around 325 cents per bushel on speculation of a record harvest in the US. The U.S. Department of Agriculture released a forecast in mid-August confirming this view. It predicted a record U.S. corn crop and the biggest yields ever, with a national average of 175.1 bushels an acre

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However, the USDA’s forecasts have been prone to major revisions in previous years. In 2010 producers were slow to realize the damage heat had caused, and this year may be no different. Hot weather across the U.S. corn belt in June and July came during critical periods of ear development.

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The USDA estimates are made based on farmer surveys, field inspections (known as windshield tours, that are essentially drive-by’s) and satellite images. But, as the image below shows, they are no substitute for actually checking the quality of the corn.

Corn prices are sitting on a key support level that was previously touched in October 2014 and June 2010. Meanwhile, market positioning shows that corn prices could be very vulnerable to a strong short-covering rally, if yields disappoint.

Buy the book Commodities: 50 Things You Really Need To Know from Amazon (US and UK), iBooks, Barnes and Noble, Google and Kobo. If you like the book please leave a review on Amazon. Reviews really do make a difference. Thanks.