Tight Supply of Palladium Expected for 2011

By Michael Montgomery—Exclusive to Palladium Investing News

Palladium has had quite a run over the last year. In the last 12 months, the metal gained over 80 percent, with prices rising to their highest levels since 2001. Since the start of 2011, palladium has seen wild fluctuations in price ranging between a low of $753 per pounce to a high of $858 per ounce. The price took a serious hit as high oil prices raised fears of inflation and weak auto sales. However as oil prices are starting to tick lower, the price of palladium has stabilized. Still fears over ongoing political tensions, oil price and inflation have left the price of the metal on shaky ground.  The majority of palladium is used for auto catalysts, so the effect of oil price on the industrial demand for the metal plays a substantial role. Going forward, the supply outlook for 2011 and beyond seems to favor a bullish outlook.

More than 80 percent of the supply of palladium comes from Russia and South Africa. The two countries dominate the market and there are signs of a lack of supply going forward. For years, Russia has controlled the price of the metal through its state reserves built up in the 1970s and 1980s from excess output of the metal. However, as a result of the increased industrial use of palladium, those reserves have been dwindling. The exact total amount of reserves are a closely guarded secret, so estimates of the size of the stockpile is pure speculation; however there are hints that the stockpiles may be running low.

“Russia, the world’s biggest palladium producer, is shipping the smallest amount of metal to Switzerland in 15 years, a sign of declining state stockpiles that may drive prices as much as 15 percent higher by December,” reported Nicholas Larkin, for Bloomberg.

The shipments to Switzerland, one of the two main trading hubs of precious metals in Europe, fell to 500,000 ounces in 2010, down from a 20 year average of 1.3 million ounces. The major drop in shipments may have been a way to manipulate the market, or a sign that reserves of the metal are disappearing. Again, the size of stockpile is a closely guarded secret, but many analysts suspect that the latter is occurring. Barclays Capital has estimated that mining output will fall 5.4 percent to 6.8 million ounces, while demand for the metal will rise 6.7 percent to 5.5 million ounces.

The ability of South Africa to increase production to meet demand this year seems unlikely. Rising production in South Africa is hampered by a lack of electrical supply from the state run power company Eskom. An energy resource plan in South Africa will be passed into law by April; however, new supply of power will take a few years to develop, and many mining firms are increasing their production in the country. “The supply-demand margin will remain slim for the next 5-6 years and in particular the next two years,” stated Kannan Lakmeeharan, an executive at Eskom.

Last Friday, NYMEX raised the margins requirements for palladium futures contracts by 25 percent to $6,875 from $5,500. “While that doesn’t really have an impact on anyone except individual futures traders, it does signal that perhaps NYMEX sees current palladium prices as a new baseline; after all, they wouldn’t bother increasing the margin if they thought these prices were simply part of a bubble,” stated Julian Murdoch, for Seeking Alpha. The high prices for palladium and PGMs may be the new normal in the market based on market fundamentals.

As the industrial demand for palladium grows and the supply tightens the strong fundamentals dictate that the price of palladium will increase over the course of 2011.Auto demand is continuing to rise, driven by increases in China. Auto sales in China are expected to rise 11 percent this year. The electronics sector, the second largest industrial use of palladium,  is also slated for gains this year. The only factor that could dent the demand side of the equation would be inflation potentially from high oil prices hurting auto sales over the course of the year.