Monday, April 1, 2013
Most readers are aware that we have been bullish on platinum group metals (PGM's) for some time now. Please see our fundamental thesis outlined here, and an update on PGM's published here. As precious metals investors, we can't imagine a better set of conditions for a breakout in the price of platinum and palladium.
Investors piled into platinum and palladium ETF's during the first quarter, driving their holdings to record highs. More than half of platinum and palladium miners cannot earn their cost of capital at current metals prices, which has already resulted in the world's largest platinum producer shutting down production. The demand for the metals is also growing, with global car production projected to hit all-time highs in 2013. Adding 'insult' to an already 'injured' industry, South Africa's largest power producer has warned that there could be rolling power blackouts this year, further curtailing production from that country's mines. This is a perfect storm for price increases in platinum and palladium: increasing demand coupled with a production profile under duress.
Last week, another bombshell dropped to support our investment case. During the Brazil-Russia-India-China-South Africa (BRICS) summit, South Africa and Russia announced that they plan to set up a consortium to control the flow of PGM exports. The consortium would be modelled on the Organisation of the Petroleum Exporting Countries (OPEC), a cartel formed by 12 nations that collectively supply about 41% of the world's oil output. This is a game changer for the PGM industry, as South Africa and Russia are the largest two producers of PGM's globally, together controlling about 80 percent of platinum group metal reserves.
According to a Bloomberg report, the two countries have so far signed a "framework" accord and are forming working groups to discuss joint actions. A meeting is scheduled this summer to discuss the mechanisms in more detail. "It can be called an OPEC," said Russian Natural Resources Minister Sergey Donskoy.
He added, "Our goal is to co-ordinate our actions... to expand the markets. The price depends on the structure of the market, and we will form the structure of the market."
Although details are sparse, investors would do well to heed these recent announcements and ponder their implications. There are few, if any, substitutes available for platinum and palladium as catalysts in auto production and other industrial processes. Since it is well known that there will be mine shutdowns planned for this year, there will likely be a significant drop in platinum and palladium production. Investors have already anticipated this and are purchasing both metals for their portfolios in record numbers - as evidenced by new flows into PGM ETF's. The big question in our mind is 'what will the reaction of industrial users be?' Cars can be sold without compact-disc players or power windows but they can't be sold without a catalytic converter. If industrial users get nervous about the availability of these important metals they will begin stockpiling, if they haven't already. Near the end of 2000, hoarding by industry users led palladium to trade over $1,000 an ounce.
While the details of this new 'cartel' and their market operations have yet to be released, we can't imagine a more bullish case for platinum and palladium prices in the near term. With auto catalyst demand increasing in 2013 and supply dwindling from all sources, we do not expect industrial users will treat these new developments lightly. The average automobile (worldwide) carries a mere $212 worth of platinum group metals per vehicle, making the impact of any platinum price increase on the total wholesale cost of an automobile relatively marginal. As there are no substitutes for the function of platinum and palladium in a car, automobile manufacturers may soon be forced to pay much higher PGM prices. Given the probability of that happening, we expect them to increase their stockpiles in the near-term, and we believe investors will benefit by doing the same.
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