Punting on palladium?

Fund buying in palladium - is this a gamble on lower Russian shipments this year?

LONDON - 

For as long as this analyst can remember (which is longer than she is prepared to admit to), Russian palladium inventories have been one of the great mysteries of the market. Plus ça change.

The palladium market has been experiencing a sharp fund-driven rally in the past week, with good volumes going through and one particular London-based bank notable in the market as a steady, sizeable buyer, while there has been activity also in the call option market. This is generally believed to be an attempt on the part of a fund or funds to force the price higher through, in part, the mechanism of triggering of stops, but the fundamentals do not, on the surface at least, suggest that this strength can be sustained.

Palladium's fundamentals are nowhere near as attractive as those of platinum, and its rally in price during September came in reaction to the heavy falls in the middle of August when it dropped from $365 towards $310 under speculative liquidation. On NYMEX, for example, the net long speculative position contracted from 1.32 million ounces to 945,299 ounces between the 7^th and 21^st August - a sharp drop of almost 379,000 ounces in just two weeks. There were further contractions thereafter, but at a considerably slower pace. The recovery in prices during September saw prices rally on an intra-day basis from $325 to $345 (6%) at the end of the month as a result of reasonably steady industrial demand and some speculative and investment buying, before running up towards $370 in the first week of October under heavy buying in the Over the Counter market.

Although there is currently reported to be a tightness in sponge, which suggests good industrial buying activity, the palladium market is expected to be in an overall surplus again this year. Société Générale, for example, is forecasting in its latest quarterly Commodities Review that palladium will be in a surplus this year of some 750,000 ounces, which is equivalent to approximately five weeks' industrial demand. The forecast is predicated on the expectation that Russia will again be shipping metal from inventory. Were there to be no such shipments then the market would be in a small shortfall. Are the current buyers taking a punt on a lack of shipments from inventory this year?

The automotive industry remains key to palladium. Johnson Matthey, which in its Platinum Group Metals survey records industrial sales and purchases, estimates that the automotive industry was responsible for 4.02 million ounces of palladium requirements in 2006, with scrap recovery of 800,000 ounces. On a net basis, therefore, JM accords the automotive sector a 55% market share. The GFMS platinum and palladium survey estimates net demand (estimated end-use demand rather than sales) at 57% of total net industrial fabrication, with automotive scrap estimated at 764,000 ounces.

Scrap recovery from the "mine on the road" has been one of the most important features of the market in recent years and is likely to remain that way as recovery has been growing at an average of 23% per annum since 1999. The rate of growth of platinum supply from emission control catalysts is more moderate at 7% per annum, reflecting the fact that in the 1970s and 1980s platinum was the dominant metal in the sector. The rapid growth in palladium use, especially in North America is now feeding into scrap recovery and the levels of return from the two metals are fast approaching parity. The growth in supplies from the automotive sector is, if anything, likely to accelerate for the foreseeable future.

The market has, however, more or less disregarded the announcement from Mazda that it (rather like Nissan in late July) has developed an emission control catalyst that uses between 70% and 90% less PGM than existing catalysts. This is understandable as the changeover to a new style of catalysts would take a considerable time before usage became widespread.

The outlook for palladium prices is uncertain. It is a relatively small market and does not need much firepower to move prices and it looks as if there are efforts afoot to force an attack on yet higher levels yet. While there is certainly a possibility that prices could forge higher on the back of sustained inflows of funds into the commodities sector, the underlying fundamentals in the palladium market suggest that it should be a medium-term under performer among the metals markets. Unless, that is, there is a cessation of sales from Russian inventory

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