Why Palladium May Be This Year’s Gold

Precious metals are rare, naturally occurring elements with a high economic value. Gold and silver derive their value from this historical use as coinage, but others like palladium have the dual benefit of being rare and useful in commercial applications. Even better, many of these applications are projected to rapidly grow, resulting in higher demand [for more palladium news and analysis subscribe to our free newsletter].

Auto Industry Drives Demand

Global automobile demand is expected to continue rising by 6% in 2012 and 2013, which is higher than its 4% rise in 2011, according to Nomura analysts. While the U.S. has experienced a strong rebound, many emerging markets have also contributed to global growth. For instance, Thailand and Indonesia have both seen strong growth amid expanding middle class incomes.

Palladium is primarily used in automobile catalytic converters, which convert the toxic byproducts of combustion into more innocuous chemicals. While most catalytic converters utilize platinum, there are high costs and some unintended reactions involved. Many manufactures therefore use a combination of other elements, including palladium as an oxidation catalyst [see also Inside Citi’s 2013 Precious Metals Outlook].

Many analysts expect platinum demand for auto catalysts to rise 100,000 ounces this year, which suggests a similar rise for palladium, since they are both commonly used in the same application. When coupled with a tighter supply, these dynamics could lead to higher prices throughout 2013, according to many industry experts.

Limited Availability Constricts Supply

Palladium is primarily mined in only a handful of different countries. South Africa dominates the supply of platinum group metals, accounting for nearly 80% of global production. Russia has also made a name for itself as being a major provider of this commodity through out the years. The gap between supply and demand is expected to come in at nearly 915,000 troy ounces in 2012, after a 1.255 million surplus in 2011, as production fell 6% around the world.

Supply concerns remain in both Russia and South Africa, with some analysts projecting an 876,000-ounce deficit for 2013. While palladium from Russia’s stockpile has helped even out demand in the past, nobody knows the size of those inventories and much of the stocks could be depleted, according to analyses based on trade data from Switzerland [see also 3 Metals Outshining Gold].

The limited supply has led to higher prices for the commodity, especially given the increased demand from the auto industry. Looking ahead, many analysts see 2013’s average prices that are steadily to sharply higher than they were in December 2012, particularly during the second half of 2013 when the global economy is expected to gain momentum.

Investing in Palladium Futures

The most direct way to invest in palladium is by purchasing palladium commodity futures on the Chicago Mercantile Exchange (CME) under the symbol “PA,” with expiration dates moving out approximately six months. These contracts trade in 100 troy ounce increments with a minimum fluctuation of $0.05 per troy ounce [see also Ultimate Guide To Palladium Investing].

These contracts can be traded using most commodity brokers, but investors should note that the contracts are physically delivered, if held through expiration. Trading is conducted over 15 months, beginning with the current month and the next two calendar months before moving into the quarterly cycle of March, June, September and December.

Palladium futures are hedging tools for commercial producers and users of the metal, while also providing global price discovery and opportunities for diversification.

Other Ways to Invest in Palladium

Investors looking for exposure to palladium have a couple of different options. Those looking for direct exposure may want to consider exchange-traded funds (ETFs) or exchange-traded notes (ETNs) that hold physical palladium, while palladium mining companies offer exposure to the commodity with the potential upside or downside of exploration activities.

The most popular ETF is ETF Securities’ ETFS Physical Palladium Shares (PALL) ETF, which offers a simple, cost-efficient and secure way to benefit from higher palladium prices, since physical metals instead of futures contracts and derivatives back the fund. With a 0.60% management fee, the ETF is also relatively affordable compared to other non-index funds.

There are many mining companies with exposure to palladium, but most of them are involved in extracting other precious metals, too. Investors should be aware that these equities might entail more risk than palladium ETFs, since companies can experience bankruptcy, while they tend to track the price of palladium with a strong correlation in spot price movements.

Some of the more popular equity plays on palladium include the following:

• Stillwater Mining Company (SWC) is a $1.5 billion producer of palladium, platinum and associated metals from a geological formation in south-central Montana, the J-M Reef and from the recycling of spent catalytic converters.
• North American Palladium Ltd. (PAL) is one of the world’s two major palladium producers that operates the flagship Lac des Iles Mine (LDI) located in Ontario, Canada with a market capitalization of nearly $210 million.
• Anglo American Platinum Ltd. (AGPPY) is the world’s leading primary producer of platinum group metals, including palladium, with a market capitalization of $13.6 billion and properties around the world.

Investment Strategies to Consider

There are many different strategies that investors can employ to take a position in palladium and benefit from higher prices. From equity ETFs to mining equities to futures contracts, there are a number of different securities that can be used to invest in commodities. These securities can be further leveraged with innovative derivative strategies.

Derivatives can also be useful in leveraging returns or implementing various strategies. Investors looking for long-term exposure at a cheap price may want to consider LEAPS – or long-term equity anticipation securities – while conservative investors may want to consider initiating a covered call option position to generate an income and lower the breakeven point.

The Bottom Line

Palladium could benefit from increasing demand and a limited supply throughout 2013, continuing many trends that began in 2012. Investors looking to capitalize on these moves have a number of different options, ranging from equity ETFs to commodity futures, as well as access to a number of different strategies involving futures and options.

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Disclosure: No positions at time of writing.