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Palladium: a ‘bubble’ that is more expensive than gold

17 february 2020

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           Image credit: Norilsk Nickel

The palladium price surge in 2019-early 2020 sets it apart from the rest precious metals. Palladium mainly used in catalytic converters for exhaust gases has outstripped the most popular precious metals in 2019 having risen in price by $ 700, to $ 1,920 per ounce. In January, palladium futures reached $ 2,500 showing a 75% increase over 12 months due to the news about declining the production in South Africa and signing the first part of a trade deal between the USA and China. The reason is the limited supply and increased demand due to tightening environmental standards in Europe and China. Despite the fact that the palladium price rally is explained by fundamental factors, the precious metal value growth rate has already exceeded all expectations and worried even Norilsk Nickel, the main palladium producer and the beneficiary of price increases. The survey by the London Bullion Market Association (LBMA) published in early February suggests that the experts do not see a market upside for palladium prices from its January maximum levels. However, there are many supporters of a different point of view - that a structural deficit amid increased consumption will ensure continued steady growth of the palladium price. This can only be prevented by replacing palladium with cheaper platinum, which is not yet seen, or the rapid development of electric vehicles at a period of stagnation of traditional gasoline cars.

GROWTH FACTORS

After a short spike in 2000, the palladium price has long been steadily lower than that of platinum that enjoys more demand from the industry and jewelry. With the development of the use of platinum-group metals (PGM) in autocatalysts resulting in lower toxicity of carbon monoxide emissions, platinum and palladium have found their application: platinum in diesel engines, and palladium in gasoline ones. The foundations for the palladium rally were laid in 2015 when the Dieselgate erupted - it turned out that the Volkswagen concern falsified the environmental parameters of their car diesel engines. After that, under the pressure of regulators, the European diesel car market began to lose ground in favor of cars with gasoline and hybrid engines, the catalytic elements of which have a much higher palladium content.

In the fall of 2017, palladium outranked platinum for the first time in 16 years, and since 2018, it has been steadily trading above gold.

Despite the fact that palladium has been preparing to take its current place for a long time, its growth dynamics in 2019 was a surprise to analysts and experts. The regular LBMA survey conducted in late 2018-early 2019 assigned palladium the role of the worst among the four precious metals (gold, silver, platinum, and palladium). The consensus result of the survey was a 3.1% drop in the average price, to $ 1,268 per ounce. As a result, the experts' forecast turned out to be 17.5% lower than $ 1,537 that had developed over the year. The key argument in favor of the fact that palladium growth would be moderate was the concerns about the automobile production growth in China and the macroeconomic uncertainty.

Despite the decline in the automotive market in 2019, the demand for metal was high. The tightening of environmental standards played an important role. “Tightening emissions legislation and stricter vehicle testing regimes are now driving palladium autocatalyst loadings higher in most major vehicle markets,” said Johnson Matthey, the world's largest platinum group metal distributor in its May review. The introduction of new environmental regulation in almost all key regions, including China 6 in China, Tier 3 in the USA, Euro 6d in the EU, Bharat 6 in India, made it possible to compensate for the negative effect of weak car sales, Nornickel noted in their report for the first half of 2019.

In 2019, following the EU, new environmental standards came into effect in China where some cities and provinces switched to China 6 gasoline earlier than it was scheduled as part of their three-year ‘Battle for the Blue Sky’ program. According to experts, this resulted in about a 30% increase in the volume of palladium in automobile catalysts for the Chinese market. “We estimate that around one-third of light-duty gasoline vehicle production this year will be models meeting China 6 emissions standards and that this will generate double-digit growth in average loadings, lifting palladium demand from the Chinese auto industry by nearly half a million ounces to 2.56 million ounces," Johnson Matthey explained in their review. The next round of tightening the environmental standards in China is scheduled for 2023.

At the same time, the decline in car sales, which accounted for 70% of the demand for palladium, was not as large as expected last year. By November, the car sales in the US showed a 2% increase after falling by 3% at the beginning of the year, in the EU - a 5% increase after falling by 2%. In China, the sales declined, but the dynamics became less depressing - minus 4% in November against minus 13% at the beginning of the year.

In 2020, according to the VTB Capital estimates, the global car sales will grow by 4.8% compared to a 4 percent drop in 2019, which will increase the palladium deficit that will grow to 1.8 mn ounces (15% of the demand). The situation will not change in the coming years and the deficit will keep on growing until 2023 when it reaches 2.34 mn ounces, the bank says.

PRODUCTION AND DEFICIT

The improvement in demand in the automotive industry is taking place against the background of decreasing metal supplies and increasing deficit, which gives rise to concerns that the growing demand for palladium will not be satisfied through the supplies that will be offered by mining companies and secondary production. The palladium production in South Africa continues to decline due to mine depletion and inadequate funding.

Historically, palladium was a by-product in mining - in Russia, it is contained in ores from which nickel was primarily produced, in South Africa - platinum was produced. The world's only palladium-rich deposits are found in North America.

The major volume of world palladium is produced by Norilsk Nickel, it accounts for 41% of the global production of this precious metal. In 2019, Norilsk Nickel produced 2.922 mn ounces of palladium and 702 thousand ounces of platinum. The company produces platinum-group metals from sulfide ores of the Taimyr Peninsula, where they are a by-product. Unlike the South African deposits, the potential of the Taimyr deposits has not been exhausted, and the top position of Norilsk Nickel will only be strengthened with the launch of the Arctic Palladium project with the reserves of about 4.3 thousand tons of platinum-group metals. Other major palladium producers are Anglo American Platinum (Amplats), the world's leading platinum producer, Sibanye-Stillwater producing 2.1 mn ounces, and Impala Platinum, with its 850 thousand ounces.

The initial supply of palladium in 2019, according to Norilsk Nickel, will be 7.1 mn ounces (an increase of 250 thousand ounces compared to 2018). The production using the scrap will also increase to 3.3 mn ounces (an increase of 100 thousand ounces). However, even taking into account the growth, the supply will be lower than the demand, and the market will continue to incur a structural deficit at the level of 600 thousand ounces.

In 2018, the demand for palladium rose to 10.1 mn ounces from 9.3 mn ounces in 2016, with the main driver being the automotive industry, its need for palladium has grown over this period to 8.6 mn ounces from 7.9 mn ounces, according to the Johnson Matthey review.

Johnson Matthey estimates the palladium deficit in 2019 at 809 thousand ounces against 121 thousand ounces a year earlier. Over the past few years, the shortage of metal in the market has been offset by the exchange-traded funds focused on palladium investments. However, since the mid-2015, the assets of ETFs have declined fivefold - from 3 mn ounces to less than 0.6 mn ounces, according to Bloomberg. Johnson Matthey says in their study that the metal reserves in the ETFs can no longer cover the difference between industrial consumption and supplies.

Norilsk Nickel expects that in 2020, the demand for palladium will increase by 4% (by 400 thousand ounces) with an increase in the supply by producers by 3% (by 300 ounces). Norilsk Nickel experts expect the excessive consumption of palladium over its production until 2025. This is primarily due to an increase in the amount of metal used in the catalysts of combustion-engine vehicles, including hybrids. “The deficit of palladium will increase due to the gradual recovery of automotive production. It is expected that this will happen thanks to the state support for car sales in China, as well as efforts by automakers to comply with new legislative requirements. In the long term, the need for significant additional production of palladium is expected, which can be ensured through the construction of new projects by its key participants and the processing of secondary raw materials,” the Norilsk Nickel report said.

BUBBLE OR an expected RESULT OF DEFICIT?

The palladium price rally has caused concerns at Norilsk Nickel that is strategically interested in reducing the volatility of the metal now bringing about 45% of their revenue. Financial speculators created a palladium ‘bubble’ in the market, which could have a bad effect on the industry, director of the Norilsk Nickel marketing department Anton Berlin told Bloomberg in January. “Direct demand from industry is not growing as fast as one could conclude based on the dynamics of prices,” he explained.

Norilsk Nickel is ready to take steps to mitigate concerns due to a shortage in the market. Norilsk Nickel mainly produces palladium in powders, but this type of precious metal is not used by financial investors. Therefore, the company plans to increase sales of investment-grade palladium bullions instead of powders used by industrial consumers. Thus, Norilsk Nickel hopes to reduce volatility in the palladium market.

The rally in the palladium market is not a ‘bubble’ and it may continue as China boosts its emission reduction program, Amplats,’ CEO Chris Griffith says. A supply deficit of about 1 mn ounces will maintain prices until the car manufacturers start replacing palladium with platinum, he says that there is a huge deficit, and this results in higher prices. He adds that this is not a ‘bubble’ and what is happening is by no means strange. There is no short-term solution to the supply shortage.

PRICE FORECASTS

The revival of car sales and the growth of palladium content in catalysts, according to VTB Capital estimates, may lead to an increase in the average palladium price in the coming year to $ 2,000 per ounce, and at the beginning of the year, it may approach $ 2,500.

At the end of January, the BofA analysts raised their forecasts for palladium prices in 2020 by 82% to $ 2,988 per ounce (growth potential of 22% to the spot price) with an expected peak of $ 3.5 thousand per ounce in the fourth quarter of 2020. The forecasted palladium price by 2021 was increased by 102% - up to $ 2,625 per ounce.

ABN Amro Bank raised its price forecasts in 2020 by 27%, to $ 1,968 per ounce, reflecting the past price increase, but noted the vulnerability of the precious metal expectations depending on the success of the electric vehicle industry. ABN Amro increased the palladium average price expectations by 2021 by 10%, to $ 1,613 per ounce.

The recent LBMA 2020 Precious metals forecasts survey suggests an average palladium price of $ 2,116 per ounce. In January, palladium reached $ 2,500, having exceeded some analysts’ forecasts for the whole year. Therefore, although the forecast figure is 38% higher than the average price in 2019, the growth compared to January is very modest - 2.5% only. This indicates predominantly conservative expectations and the possibility of a sharp decline in metal figures in 2020. “it’s a case of fasten your seat belts, we could be in for a bumpy ride in 2020,” concludes LBMA.

However, it is difficult to guarantee that the reality will not be able to get ahead of the forecasts again. One of the most successful forecasters in the history of LBMA surveys, independent analyst Ross Norman, whose forecast for palladium in 2019 turned out to be the closest one to real figures, expects an average price at the level of $ 2,485. “Perversely, speculators have been entirely absent from this bull run, with ETF holdings sliding by about 1moz over the last two years,” Norman says. “So prices have been rocketing despite ETF redemptions,” he explains. “A worsening eight-year supply deficit has seen a steady drawdown in above-ground stocks. Critically, as these near exhaustion levels, the impact on palladium prices will become disproportionate, by going exponential.”

RISKS

The key story for palladium is the demand from the traditional automotive industry and the increase in the production of gasoline or hybrid vehicles.

The risk for the rally is a decline in car sales, which eases the pressure on prices, but so far, this has been offset by tightening the global emissions standards, Ross Norman concludes.

“The bubble could be set to burst, as the automotive industry, which has been singularly responsible for the growth in demand for palladium, might be cooling on the metal’s potential,” says D. Casey, a Mining Technology blog analyst.

He also notes the symptoms that the supply is starting to catch up with the demand - a number of projects are in the process of obtaining permits or previously mothballed projects are being put back into operation preparing to contribute to the supply of the market with metal. In particular, a Canadian miner Ivanhoe completed the feasibility study of the Platreef project in South Africa where it plans to produce 219 thousand ounces of palladium per year. North American Palladium plans to continue underground operations at its previously mothballed (due to low prices) Lac Des Illes mine in Canada and produce 2.32 mn ounces of metal there until 2027. The American Platinum Group Metals, in partnership with industry heavyweight Implats and the JOGMEC, is investing $ 874 mn in the Waterberg project in South Africa having 19.5 mn ounces of palladium reserves. The company expects Waterberg to become one of the most profitable mines in the industry producing annually about 420 thousand ounces per year for 45 years. Nevertheless, as we have already noted, the projects related to core production of palladium are very rare; often even large reserves do not always guarantee their financial attractiveness, therefore, industry leaders will not have large competitors for decades to come.

The ABN Amro review says “In the long-run, the fortunes of palladium will depend crucially on the success and acceptance of electric vehicles.” “If this market takes off, but overall car sales remain moderate, then demand for palladium will be far lower. With this in the back of their minds, miners will likely be reluctant to invest in palladium mining capacity that would take a few years to build. They will likely try to profit from the current state in the market and cash in on these high prices. We have changed our palladium price forecast to reflect the price surge, but our view is that if the market calms down the price should be close to USD 1,500 per ounce based on fundamentals,” the ABN Amro analysts say.

Another risk is the substitution of palladium in platinum autocatalysts. The platinum price dynamics are less impressive than those of palladium - last year, the metal price rose by 21%, not compensating for the losses caused by Dieselgate. According to the results of 2019, the palladium-platinum premium reached $ 675, which raises the question of the motivation for the use of cheaper and similar platinum in autocatalysts.

According to analysts at the Bank of America Merrill Lynch, although limited supplies of palladium still support prices, automobile makers may turn to alternatives. This is due to the fact that in the next few years, automakers may experience irregular palladium supplies, as the global supplies will remain at the same level (about 10.2 mn ounces per year). Bank of America’s analyst Michael Widmer says to the Financial Times that automakers are starting to look for a replacement. It will probably take another 12-18 months. The sooner they will find a replacement or change the catalysts, the faster the rally will end.

“With palladium prices setting new records in the first quarter of 2019, and the premium over platinum widening to over $600 per ounce on average, there has been increased speculation about the potential to move away from palladium and towards platinum in some autocatalyst applications,” Johnson Matthey said in the review last year.

Nevertheless, Johnson Matthey stated, “However, to date, recent palladium price gains have not had any measurable impact on automotive PGM demand.” “Looking forward, there may be near-term potential to replace some palladium with platinum in the light-duty diesel sector. Substitution in gasoline three-way catalysts will take longer to achieve and will require significant improvements in technology,” Johnson Matthey emphasized.

Platinum and palladium, for all their similarity, have a number of differences in properties, explains Johnson Matthey. “High palladium prices have led to an intensification of programs to develop and test platinum-containing three-way catalysts. However, it remains difficult to match the performance of existing palladium-rhodium catalysts, because palladium has better thermal stability than platinum under typical gasoline exhaust temperatures. Even if platinum-rich three-way catalysts can demonstrate equivalent performance, any meaningful substitution is likely to take at least two to three years,” says Johnson Matthey.

Norilsk Nickel also does not see signs of a threat to palladium due to its rise in price. “According to our observations, auto groups are in no hurry to replace palladium with platinum, because at the moment, all their efforts are aimed at meeting the new environmental standards, especially taking into account more demanding tests in real driving conditions,” the company noted.

Igor Leikin for Rough&Polished