Palladium has been the stand out performer in commodity markets over the past three years – up 160%. Palladium, mainly used in catalytic converters to control emissions from gasoline engines has been supported by a switch away from diesel vehicles and by the introduction of tighter vehicle emissions standards in China and elsewhere in the world.
Investors look to play the price differential
Investors reluctant to follow the bull market in palladium have been looking at alternative ways to bet on increasing emissions standards. The other main metal used in catalytic converters is platinum. Platinum demand has been under pressure since 2015 following the Volkswagen diesel-engine emissions cheating scandal in the US.
Platinum is extremely cheap compared with palladium. Platinum prices have declined by 17% over the past three years while the platinum/palladium ratio has declined to its lowest level since 2001.
Chart 1: Platinum/palladium ratio
However, that of course doesn’t mean the ratio has to correct through higher platinum prices. Lower palladium prices and/or a combination of the two works just as well.
Switch to platinum will take time
Some investors it seems are backing the former. Holdings in platinum-backed ETFs have surged by 15% this year to reach a 4 year high as investors bet that carmakers will start to use the metal in petrol car catalysts.
But according to the car industry a substitution towards diesel is far from being a done deal. Rahul Mital, global technical specialist at General Motors suggested at a London Bullion Market Association meeting late last year that it would take some time to switch and even then the price benefits don’t necessarily warrant it:
“Any time you want to make a substitution like that, it is at least 18 months to a two-year cycle if we’re going to switch. We have to be careful that by the time we do all that.”
According to the World Platinum Investment Council (WPIC) a 5% substitution would mean a 14% increase in platinum demand from the automotive demand segment. However, given that catalyst demand is roughly half as important to platinum demand as it is for palladium (40% vs 79%) it may take a large switch to have a material impact on overall platinum demand.
Chart 2: End market demand
Fog of uncertainty
The car industry is battling declining sales in China and other markets. If auto-sales growth really does fall off a cliff (perhaps if a global recession hits) then demand for both palladium and platinum decline.
Chart 3: Annual growth in car sales in China
The car industry is facing increasing demands to invest in electric vehicle capability to head off the perceived threat from Tesla and others who have a head start. Is now really the time that they will be tinkering with the amount of metal in their catalytic converters?
History is also not on the side of price booms in metals thought essential continuing indefinitely. Just look at the price of cobalt over the past year and rhodium a decade ago.
Related article: What lessons does rhodium have for commodity investors?
Constrained supply after one-off boost
A new report by the WPIC predicts that platinum mine-level output will rise by 6% increase in 2019 to 6.46 million ounces on top of a 3% boost to recycling. The WPIC said supply growth would come mainly from the release of material stockpiled by mines and smelters in South Africa (responsible for 70% of global mined output) during upgrades and maintenance over 2017 and 2018. If this occurs it will clearly be a one-off boost to supply.
More generally platinum output from South Africa is frequently disrupted by power cuts, strikes and unrest. There seems little chance of that changing. More than 60% of South Africa’s platinum mining industry is loss-making or marginal according to Minerals Council South Africa. Labour costs have been increasing faster than inflation, whilst revenue from metal sales has been declining due to low platinum prices.
Chart 4: Forecast change in platinum supply
An industrial metal but a precious one too
Both platinum and palladium have their uses in applications other than catalytic converters. Jewellery for one but they are also held by investors as a ‘beta’ version of more commonly held precious metals like gold and silver. If gold prices come under pressure (perhaps because of reduced geopolitical tensions, lower inflation expectations and / or higher bond yields) then investor demand for palladium and platinum will also suffer.
Unlike gold and to a lesser extent silver, the PGMs suffer from poor liquidity and an opaque market. The PGM group of metals (palladium, platinum, rhodium and others) are very small markets relative to gold or indeed even silver. This means that prices can go from being an investors best friend to their worst enemy in the blink of an eye.
Related article: Platinum prices: The top 10 most important drivers
Platinum prices have been on a downward trend since 2011 frequently coming up against trend line resistance along the way. Since August prices have attempted to push up towards the trend line again (rising $100 per oz to reach $875 per oz) before failing to push past in in late February and then retracing half of that run-up in just a few days.
Chart 5: Platinum prices
Although speculators have recently turned net long it is going to take a break of this trend-line combined with confirmation of car-makers intent to seriously switch towards platinum for investors to run platinum higher.
Chart 6: Managed money positioning