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Russia, Georgia-Nato crisis: Palladium supply disruption looming?

We are living in a world of increasing geopolitical tensions (terrorism, nuclear proliferation, new superpowers’ confrontation, oil crises, new cold war…): the world is changing and a new international equilibrium must still be found. The latest front in this scenario and the most immediate source of potential troubles is the Russia-Georgia crisis with the external involvement of the USA and its NATO allies. NATO Secretary-General Jaap de Hoop Scheffer said on Tuesday August 19, 2008 that there can be no business as usual with Russia under the present circumstances. The announcement came after foreign ministers from NATO member nations gathered in Belgium for an emergency meeting over the crisis between Russia and Georgia which also involved U.S. Secretary of State Condoleezza Rice. Rice said ministers would also will discuss how to support states on Russia's borders that have already joined NATO, including Poland, Latvia, Lithuania and Estonia. I will focus here on the potential consequences for PGMs and SWC of an escalation in the Georgia crisis. Russia produces 40% of the annual Palladium mining supply and owns the only Palladium stock existing in the world (roughly 4 million ounces or approximately 6 months worth of Global consumption), Russian sales of mined Palladium and stocked Palladium account for more than 50% of the world annual supply of Palladium. A crisis involving confrontation or escalating tension between USA and Russia will have a major impact on PGM and on Palladium in particular. For my own reference I checked what happened in the PGMs market during WWII going through the USGS Minerals Yearbook for the years from 1940 to 1945 ( Platinum and Allied Metals section of H.W. Davis): during the war period PGMs refined imported and consumed in the USA increased more than in any other previous year stimulated by defence activities in the chemical and electrical industries. Supplies of PGMs in 1944 were not adequate to permit their use for non essential purposes, the deficiency was met by larger imports (mainly from Canada and Russia) and by the release of the US government stocks. Note that US stocks of PGM in 1943-44 were 323K ounces or 75% of the annual US consumption at that time (annual uses of PGM in the USA in 1944: 450K ounces). Various trading limitation for PGMs were adopted by the US government such: Conservation Order M-95 effective March 11, 1942: Rhodium use for jewellery prohibited, Conservation Order M-162 effective effective May 30,1942: Platinum traffic outside approved trade channels suspended, Conservation Order L-45 April 15, 1943 restriction for Palladium and Gold use in the jewellery sector. What saved the USA during WWII from running out of PGMs were the adequate level of stocks and the imports from producing countries like Russia and Canada. Today things are really different: the USA net import reliance of PGMs as percentage of apparent consumption is 91% for Platinum 91% and 82% for Palladium. Last year Russia accounted for more than 50% of all Palladium imports in the USA (including Palladium sales from UK and Germany originated from Russian metal). The US National Defense stockpile of uncommitted inventory is less than 10,000 ounces of Platinum and zero (yes: zero) of Palladium as of 9-30-07 (USGS mineral commodity Summaries for PGM 2008). No wonder recently the US Defense National Stockpile Centre announced a suspension of Platinum sales (August 7, 2008) (Palladium sales did not need to be suspended because the Defense National Stockpile is already empty…..). In the event of escalating tensions with Russia the USA can suddenly loose its most important source of import of PGMs and being left without stockpiles it will experience in a dramatic supply disruption shock, a situation much worse than it was during WWII when the USA had adequate PGM inventories and when the USA were technically fighting alongside Russia (major PGM producer) against the Nazis . recently Investors have been focusing on slowing car sales in the Western world liquidating their PGMs holdings: recent COT data show that large speculators and retailers keep reducing their holdings while commercials keep buying at levels previously seen only in the occasion of major bottoms. I believe that focusing on car sales and slowing demand for PGMs in the western world during these troubled and very dangerous times is really a very short-sighted investing strategy: investors should rather hoard PGMs and, if anything, not sell them and keep them tight.

DISCLAIMER: Please do your own diligence. I am not responsible for your trading decisions, I am not an investment advisor/professional. This blog, is general market commentary only. It is not intended as specific advice. You should talk to your own investment professionals for specific advice.

Platinum Palladium Spread

The Platinum/Palladium spread is a ratio of very much interest for PGMs analysts and traders but there is not much freely available litterature about it. I will try to analyse it in this post from an historical, technical and fundamental point of view and I will finally try to make some hypothesis on its future direction.

Daily Pt and Pd charts

The first chart below shows the historical values of the ratio Platinum price/ Palladium price (also simply known as Platinum Palladium spread) while the second chart below shows the historical values of the difference Platinum price - Palladium price (also simply known as Platinum Palladium Premium):

It is very interesting to note that the Platinum Palladium Premium is trading at its all time high these days while the Platinum Palladium Spread is still far from its all time high of July 1968 when the Platinum price was almost 7 times the Palladium price (292/42).

Palladium and Platinum have roughly the same level of mining supply per year (around 7 million ounces in 2006 and 2007) and are consumed mainly by the same consuming industries ( autocatalysts, jewellery, electronics).

Platinum has historically been more expensive than Palladium, as much as 3 or 4 times on average from the fifties to the nineties. Palladium was more expensive than Platinum only during the Russian supply crisis of the late nineties: from January 2000 to July 2001 Palladium traded higher than Platinum on uncertainties over Russian exports and emergency stockpiling of north American automakers. Once the year 2000 supply crisis was over, the historical trend of significant Platinum richness over Palladium was quickly re-established: that was the trend for the last 6 years.

Today the price of Platinum (almost 1400) is exactly 4 times as high as the price of Palladium (almost 350) and the Platinum Palladium premium stands at 1050.

The very high level (all time high) of the Platinum-Palladium premium is drawing some attention to the question whether such Platinum richness over Palladium may promote among PGM users and consumers a switch trend toward Palladium.

Having a look at demand/usage forecasts of PGM producers such Implats and Stillwater Mining for 2007 it looks like Palladium cheapness is already creating substitution trend in jewellery and in the autocatalyst sector. The CEO of Stillwater Mining at the Denver Gold Forum in late September forecasted a record year in 2007 for Chinese Jewellery demand for Palladium (up 25% from 1 million ounces to 1,250,000) and a reduction of Chinese Jewellery demand for Platinum (down 10% from 780K to 700K ounces).

The charts below shows the Palladium vs Platinum substitution trend which is taking place analysing annual demand of Palaldium (000 ounces) for autocatalysts and jewellery.

The switch to Palladium of important segment of PGMs demand such autocatalysts and jewellery is suggesting me that the trend of Platinum appreciation versus Palladium may be close to a pause or correction in the coming years. The most important factor pressuring on the downside Palladium vs Platinum is the issue of the Russian Palladium stockpiles which I have already analysed in my previous post. If I am right an the existing Palladium stockpiles are lower than believed the price adjustment between Pt and Pl may take place sooner rather than later . In any case, once the Palladium stockpiles will be finally depleted, regardless of their size, the most important factor holding down the price of Palladium will be removed and the Platinum Palladium Premium will correct severely in my opinion.

DISCLAIMER: Please do your own diligence. I am not responsible for your trading decisions, I am not an investment advisor/professional. This blog, is general market commentary only. It is not intended as specific advice. You should talk to your own investment professionals for specific advice.

Russian Palladium stockpiles

The Russian Federation dominates world palladium production and supply through Norilsk Nickel output and through strategic state stockpiles. These Russian palladium stockpiles were built in times of excess supply, during the seventies and eighties, and used in order to balance the market. During the nineties when Norilsk Nickel production could not meet growing palladium demand from the autocatalyst sector, the gap was filled by State stockpiles from Gokhran, the Russian precious metals agency (which is part of the Ministry of Finance), and by the Russian Central Bank sales. The de-stocking process of the nineties was quite aggressive because of the need of the Russian government to raise hard currency during the first delicate years of the post-soviet era and because of the strong western carmakers demand of Palladium for autocalysts due to tightening emission control regulations. It is estimated that between 1993 and 2001 approximately 18 million ounces of Palladium were sold from the Russian stockpiles to western markets. How much Palladium is left in the Russian stockpiles? The actual level of Russian stockpiles of palladium is a closely guarded State secret, for this reason it is a difficult task to estimate the real size of these stockpiles: some interesting research has been done by Alan Williamson and of HSBC and John Reade by UBS, their research papers can be easily find in the web using a search engine like google, I suggest to those interested in this matter to read those papers, they are really well written and very informative.

The common view and consensus in the market is that there are still significant stockpiles in Russia and that part of those stockpiles are now held in Switzerland, this consensus is one of the main reason that make most of the analyst neutral or slightly bearish on the Palladium fundamentals despite growing demand and contracting mining output.

Despite the bearish analysts consensus view, the price of Palladium has been rising for two years and this is in sharp contradiction to the bearish consensus on its fundamentals, since I believe that the market price of a commodity is an efficient indicator of its fundamentals I have started to question the analysts bearish consensus and I decided to do some further research in order find out more about the actual level of Russian palladium stockpiles: either the analysts are wrong or the Palladium price is wrong.

Some interesting observation on this subject are also found on a friend’s blog, however I would like to add to this friend simple and straightforward observations some analytical data and produce a rigorous fundamental study on this matter.

To start my research first it is necessary to find a certain level Russian stockpiles in a particular year in order to study flows of metals from that particular year in and out of Russia. The most reasonable starting year must be year 2001 since there is a quite broad consensus on the levels of Russian stockpiles in that year. It is well known that Valery Rudakov of Gokhran in 2000 said that the Russian stockpiles were approximately 6 -10 million ounces at that time (I will assume 8 million ounces right in the middle of the range) and it is also well know that in August 2001 Norilsk Nickel suspended for the rest of the year sales of Palladium in the spot market stocking probably up to a couple of million ounces. Using the above information it can be assumed that at the end of 2001 a realistic estimate of Russian stockpiles of Palladium can be 10 million ounces.

Now I will use Russian Palladium production data and Russian Palladium export data from 2002 to 2006 to estimate the change of the Palladium stockpile level: it must be noted that Russia does not provide exports data of Palladium, however, the rest of the world releases import data of Palladium from Russia so the export data can be worked out.

I will also analyse the destination countries of the Russian palladium export since some of then are end users of Palladium (i.e. they consume the imported Palladium) others are not end users and may trade, transform and resell or simply restock the metal.

The chart below shows the de-stocking process implied by the net difference between Russian export and production of Palladium.

The chart below shows the resulting change of level in the Russian stockpiles of Palladium.

Accordingly to my calculations the stockpiles of Palladium in Russia are 3.1 million ounces at the end of 2006: these 3 million ounces are probably held by the Russian central bank since it is known that Norilsk Nickel has no stocks left.

Now it is crucial to analyse from customs data where the Russian exports of Palladium from 2002 and 2006 went: the table below shows the breakdown of Russian exports by destination accordingly to importing countries customs data (in ounces):

The main importer of Russian Palladium export is USA (7 million ounces) followed by Switzerland (6.8 million ounces) and Japan (4.8 million ounces): USA and Japan consume Russian Palladium mainly to produce autocalysts, as well as Korea. Italy is a car manufacturer country and a jewellery country. UK has imported 1.2 million ounces of Russian Palaldium, but the bulk of it was shipped to USA as payment for Norilsk acquisition of Stillwater Mining in 2003. China is also an importer of Russian Palladium and ots imports are already significant if counted together with Hong Kong imports (China+ Hong Kong imported more than 600K ounces from Russia) and I expect China to become within 2-3 years the main importer of Russian Palladium.

The anomaly of the above data is Switzerland since it is not and end-user/consuming country but a hub for international transactions in palladium. During the last 5 years Switzerland imported 6.8 million ounces from Russia, the consensus view of the analysts community is that the bulk of it is owned by the Russian central bank and it is just in Swiss custody, if that was true, then Russian stockpiles would still be 10 millions ounces as well as in 2000, however I do not believe to this consensus, so I made some further analysis of the Swiss Customs data on flows of Palladium.

I have collected and analysed Swiss import and export data of Palladium from 2002 to 2006 with its main trade partners in order to figure out where are now the 6.8 million ounces of Russian Palladium supposed to be held in Switzerland vaults, the results of my analysis are very interesting as shown in the table below:

From 2002 to 2006 Switzerland has been a net exporter of Palladium: 1.4 million ounced were shipped to Hong Kong ( therefore China through Hong Kong has bought directly from Russia and indirectly from Switzerland as much as 3 million ounces of Palladium in the last 5 years). Switzerland has also shipped a net 1 million ounces to US and 600k to Japan. Summing the net export (Export-Import) it looks like Switzerland has been a net exporter of 3,4 million ounces of Palladium from 2002 to 2006.

Using the above data it is clear that now Switzerland has only 3,4 million ounces left of the original 6,8 million ounces imported from Russia. It must also be noted that not all of this remaining 3,4 million ounces of Palladium left inside Switzerland belong to Russia: part of it may have well changed hands: Switzerland launched in 2007 a Palladium backed ETF, Credit Swiss has forged Palladium bars and coins through Valcambi, Novartis Pension Fund has been reported to buy physical Palladium among other precious metals to diversify its assets.

CONCLUSION:

The level of Russian stockpiles has been shrinking significantly over the last few years, there may be, accordingly to my calculations, no more than 3 million ounces left inside Russia and approximately a couple of million ounces left in Switzerland: the Palladium market has absorbed unnoticed the Russian destocking of the last few years and has been trending higher, a sign of an incredible underling strength. The level of the stocks left is just worth 10 months of yearly Palladium mining output, with increasing demand coming into the market from China I am very bullish on the Palladium prospects despite the bearish consensus out there.

DISCLAIMER: Please do your own diligence. I am not responsible for your trading decisions, I am not an investment advisor/professional. This blog, is general market commentary only. It is not intended as specific advice. You should talk to your own investment professionals for specific advice.

Palladium reserves and Palladium shortage

Over the last few years there has been a lot of talking about diminishing oil reserves and peak oil production: the time at which the peak in oil production will occur will depend on the rate of consumption and amount of ultimate oil reserves in place. The current mean estimate of proven oil reserves are estimated between 950 and 100 billion barrels, at the current production rates there are sufficient proven reserves to meet oil demand for at least some 40 years, the current mean estimate for the peak of world oil production is between year 2010 and 2015.

But what about the PGMs outlook? There is little or no literature about the PGM expected peak production and reserve average life estimate, this is quite strange considering that PGMs are the most rare metals on earth, and their usage is widespread and vital for the world economy.
Considering as an anomaly this lack of information and material about the PGM reserves life outlook, I decided to do some elementary (I am not a geologist) calculation and estimate. I will focus on Palladium reserves in this study.

The starting point of my research is the current USGS estimate of existing PGM reserves reported in the table below:

The USGS defines reserves (reported in kilograms in the above table) as the part of the reserve base that could be economically extracted or produced at the time of determination. The term reserves need no signify that extraction facilities are in place and operative.

Starting from this data I have tried to estimate the existing world Palladium reserves in Troy Ounces from the above PGM aggregate figures: I assumed that 77% of North America PGM reserves consist of Palladium, 85% of Russia PGM reserves consist of Palladium and 30% of the South African and rest of the world reserves consist of Palladium. It is known that deposits in the North hemisphere are Palladium rich and in the southern hemisphere are Platinum rich, following the calculation based on these assumption I obtained the table below for the existing world Palladium reserves (in troy ounces) as base for the successive estimates.

It must be noted that 2006 reserve estimate is the highest ever reported from the USGS.

To estimate the production figures for the upcoming years I used the following annual output growth rate: 3% for South Africa, 1% for North America, 2% fro Russia and 5% for the rest of the world. It must also be noted that South African, North American and Russian PGM producers are predicting mining output growth in excess of 5% for the next years, if that was the case, then my estimate for the depletion of reserves would result too conservative. Most PGMs producers however have a bad track record as far as their ability to match their growth promises is concerned, for this reason I am more confident with my slower rate of growth estimation.

Using the above assumption and existing world reserves as starting point of my analysis I found a very surprising and alarming result: Palladium reserves may run out at the same time of oil reserves. The chart below shows the world Palladium reserves (in thousands) and their gradual depletion over the next 50 years. US reserves may be over by 2046, Russian reserves by 2041 and South African reserves by 2080. It must be noted that output rates may decrease with diminishing reserves so the actual chart may look more bell shaped than my estimate chart.

What can change this outlook?

-Best case scenario: new deposit are found (for example exploration companies are searching for PGM in Alaska and Finland), higher PGM prices increase the existing reserves (the upside is small however since the USGS estimates that existing PGM resources are just 20% higher than reserves). In this scenario we will run out of PGM later than my estimate.

-Worst case scenario: no major deposits are found and producers increase their output faster than my estimate, in this case we will run out of PGM sooner.

Conclusions:

It looks like a sound long term investment to be long and hold into the next decades PGM producers and PGM exploration companies as their reserves will become more and more scarce their will be also more and more valuable.

DISCLAIMER: Please do your own diligence. I am not responsible for your trading decisions, I am not an investment advisor/professional. This blog, is general market commentary only. It is not intended as specific advice. You should talk to your own investment professionals for specific advice.

Palladium demand trends

In my previous post, I have analysed the historical trend of Palladium supply by studying the world Palladium mining output from the beginning of the last century to the present time. In this post, I am focusing on the Palladium historical demand trends. A brief introduction on the procedure followed to analyse the time series: first I collected data from various sources (mainly USGS, Johnson Matthey, and various international Customs statistics), second the data from different sources were harmonised and the outliers eliminated. Third some missing data were extrapolated from correlated data such as stocks/inventories and import/export data and finally some missing data were interpolated. These kind of data-adjustment process was unavoidable since the oldest statistics (back in the thirties and forties) were poor compared to the most recent ones (Johnson Matthey annual PGM reports were very useful for most recent data).

As far as the nominal amount is concerned, it is clear from the above chart that the Palladium market is characterised by long period of excess supply followed by long periods of excess demand: it is rarely balanced and this fact alone explains the high level of volatility of the Palladium price.

The cyclicality of the excess demand/excess supply in the Palladium market is more evident when the data are charted as percentage (of the supply). The large and prolonged % surpluses of the thirties may be explained with the weakness of the economy during the great depression while the recent large % deficit of the nineties with the excess demand created by the autocalysts sector.

It is very interesting to study how the Palladium price reacts to this cyclicality of the demand-supply excesses in the Palladium market: are prices leading or lagging indicators of a unbalanced situation of demand and supply? Intuitively they should be a leading indicator, however it looks like the price of palladium has the tendency to raise after periods of shortage of Palladium rather than anticipate it as shown by the chart below.

Finally the chart below seems to confirm that the Palladium price looks like a lagging indicator of changes in demand.

Demand breakdown: the chart below shows Palladium demand by application over the last 25 years: the price spike of 2000 and 2001 forced consumer industries to look for substitution metals and to switch their demand to Platinum: particularly in the autocatalysts and electronics sectors.

I believe that the current Platinum-Palladium price spread very favourable for Palladium will reverse this trend pushing for more substitution from Platinum demand to Palladium demand especially in the autocatalysts sector: this predicted increase in substitution demand, the increasing Palladium investment demand and the additional demand coming into the market for new Palladium application in an environment of decreasing rate of growth of Palladium mining output should bode well for Palladium price outlook in the coming years.

Palladium world mine production

Following an extensive research I have collected data from various sources such (USGS, Johnson Matthey, US Census, Customs, Producers…) and harmonised them in order to produce a Palladium world mining output history time series going back to the beginning of 1900. Below is the chart of the yearly world Palladium production (in thousand troy ounces)1915 to 2007. As far as the nominal amount is concerned, it is clear from the chart the great increase in supply of the seventies and eighties following the increasing demand of the world automakers for catalytic converters. The output growth stalled at the end of the nineties and resumed its growth after year 2001 following the spike in prices of the same year due to Palladium shortage, shrinking Russian stockpiles deliveries and aggressive automakers accumulation. The world producers invested heavily in new mining supplies, especially in South Africa following 2001 and the total supply increased up 7 million ounces per year over the last few years. It is very interesting to note, however, that the rate of increase in world output has started to decline over the last couple of years following almost 10 years of increases: this is a very interesting situation, we have now an average 5 years rate of growth of 3% (actually 2007 output is projected to be almost 5% below 2006 level). New and additional demand for potential new Palladium application is gradually emerging for the next few years (Fuel cells, food insert, hydrogen purification, diesel catalytic converters…) and considering the declining Palladium output rate of growth I expect the Palladium market to enter a new structural phase of supply deficit over the next few years. Additionally, no new resources have been found over the last few years with no new major palladium deposits found, and, even if new deposits can be found in the next few years it will take a long time before turning them in operational mines. I am therefore very bullish for the long term price of Palladium.