The Palladium Play - Part 2

Part 2 in Sprott's palladium series explores the unique supply/demand fundamentals that support their bullish outlook; Part 1 provided a primer.

Palladium's Chronic Supply Deficit Pushes Prices Higher

Palladium was a standout performer in 2018, not just among its precious metals peers but across major asset classes, as John Ciampaglia, CEO, discussed in his post on palladium last week. At yearend 2018, spot palladium prices closed price-per-ounce, having gained 18.6% for the 12 months. For the three-year period from December 31, 2015, to December 31, 2018, palladium’s price more than doubled, from $563 to $1,262 (up 124%).

 A double-digit price appreciation is a healthy return in any year, but palladium’s gains are even more impressive against the backdrop of struggles that every major asset class faced in 2018. By comparison, spot gold, platinum and silver all declined last year (1.6%, 14.5%, and 8.5%, respectively). U.S. equities, now in a bear market, lost 4.4% in 2018 as measured by the S&P 500 Total Return Index.1 According to The Wall Street Journal, the only other asset class to best palladium in 2018 was the commodity cocoa which gained 27.7%. Equities across the board were down, with the exception of the S&P 500 Health Care sub-sector (up 4.7%).2

Figure 1. Palladium’s Stellar Three-Year Rise (12/31/15 – 12/31/18)

Source: Bloomberg. XPT represents platinum; XAU represents gold; XPD represents palladium, XAG represents silver; SPXT represents S&P 500 Total Return Index.

Fixed Supply, Meet Growing Demand

At the time of this writing, palladium prices had overtaken gold for the first time since 2002 ($1,344 versus $1,295 as of January 9, 2019). Palladium’s price appreciation is best understood by analyzing the very unique supply-demand dynamics behind the metal.

Palladium mining is exceptionally concentrated with Russia and South Africa accounting for 79% of the estimated 2018 production. Typically, palladium is a by-product of mines that are built to extract other key industrial metals like platinum and rhodium, since palladium tends to co-occur in these ore deposits. Although palladium prices have doubled since the end of 2015, this increase has not been material enough to entice meaningful production increases from existing mines or investment in new mines, given the complex and relatively inelastic extraction economics of palladium mining. Looking ahead, we believe that palladium mine supply will remain fixed, with no large palladium mines coming online in the near term.

Figure 2. Palladium Mine Supply by Country (2018)

Palladium Mine Supply by Country

Source: Johnson Matthey.3

Autocatalytic converter use accounts for 75% of the net demand for palladium. This trend appears to be on the rise and is being driven by several factors. Air-quality standards for automotive exhausts are on the rise around the world as countries such as China and India grapple with smog. This has necessitated increased use of palladium in catalytic converters. The drop in diesel automobile sales due to the now infamous “Dieselgate” has led in higher sales of hybrid and gasoline powered automobiles. Well into the 1990s, platinum was used to catalyze the conversion of noxious automotive emissions in both gasoline- and diesel-powered cars. Palladium was substituted with platinum as a way of lowering the build cost of a catalytic converter in gasoline and hybrid automobiles.

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