PGM - Supply to Shrink while Demand Expands!

The Platinum Group Metals (or PGM) actually consist of 6 metals, but the term commonly refers to the Platinum and Palladium markets at the CME.

Some analysts will suggest that dramatic reform of the African platinum industry is unavoidable and that the reform will not be carried out without significant turmoil. Travails in the South African mining sector have already become chronic, with significant tumult taking place in both the gold and platinum sectors on a biannual basis. Prior to the 2013/2014 platinum strike, there were unprecedented violence and deaths in a 2012 platinum mine strike, and there was a gold mine strike in 2013. Now there are worries that the conclusion of the 2-year deal that ended the 2012 walkout will result in a protracted labor dispute later this year and into 2015.

The 2014 platinum strikes weren’t as deadly as previous labor disruptions, but they lasted a long time, and they interrupted production at three major mining companies. The South African government mediator had trouble fostering a deal because profitability at many platinum mines is already razor-thin, and  escalating wages, energy costs, and other costs associated with deep mining have left them operating in the red.

In an effort to countervail the escalating wages, which now represent more than 50% of total costs, mining companies in the South African platinum belt have already dramatically reduced investment in equipment and exploration. That will make obtaining additional supply even more difficult in the future.

While traders are currently focusing their attention on problems in South Africa, by the end of 2014 they might be looking at supply-related problem in Zimbabwe. The government there has already served notice that under their “indigenization” program, mine owners will have to transfer some percentage of their ownership to local Zimbabweans.  But the most incendiary development is a new government regulation that says that before the end of 2014, PGMs mined in Zimbabwe must be refined in Zimbabwe. The theory behind this is to create more jobs, but with mining companies having to give away some of their assets and being forced to channel their output through an underdeveloped value-added refinery structure, clearly there is a potential for a sustained disruption of supply flow to the world market.    

Demand to Outstrip Supply Again in 2014

Global platinum consumption outpaced production by an estimated 500,000 to 650,000 ounces in 2013, and early forecasts call for a deficit of 700,000 to 900,000 ounces for 2014. A historic tightening of supply could be underway. Similar shortfalls are being seen in palladium as well, and this will make it difficult for industrial consumers to substitute one for the other as they have in the past. Reserve supplies of both platinum and palladium were reportedly used extensively in the first half of 2014 to offset strike-idled production. This could leave strategic and end-user supplies as the sources of last resort in the year ahead.

While the supply side of the equation is major concern, demand patterns are not to be discounted, especially with the developing world rushing headlong into car ownership.  China appears to be well on its way to being the second largest market for auto-catalyst metals, with the most recent full-year consumption pegged around 1.5 million ounces.  While many think China will focus its clean-air efforts on coal and other industrial polluters, the government is moving ahead on automobile pollution too. New auto emission standards will increase the amount of PGMs needed per vehicle from the current 2 grams to 4 grams (the current US standard) and eventually 6 grams (the current Euro-zone standard). China’s PGM consumption could rise sharply, even if car sales slow from their breakneck pace.

Understanding the Platinum Group Metals Trade

Like most other metals, platinum and palladium tend to take direction from gold, especially in the face of financial market uncertainty and safe-haven demand. However, platinum and palladium tend to lag behind gold during periods of widespread fear and anxiety because they don’t have as strong a reputation as a safe haven. Also, platinum and palladium tend to have a greater percentage of traders and investors making decisions based on classic supply and demand issues than gold does, and as a result, PGMs are often seen tracking positively with “risk on” conditions and negatively with “risk off” events. 

Platinum and palladium can be seen primarily as industrial commodity markets, with a measure of safe haven and flight to quality mixed in into their complexions.  Platinum and palladium have at times become the primary benefactors of safe haven and anxiety conditions, but that has usually taken place after gold has gotten too expensive and traders go looking for cheaper alternatives. Typically, platinum and palladium trade inversely with the US Dollar, as higher Dollar exchange rates discourage interest in physical commodities, while a lower Dollar boosts interest.  

On a day to day basis, PGM metals prices exhibit significantly more independence from gold than silver does. On some occasions, PGMs tend to track tightly with copper, equities and energies. Still, the predominant focus for platinum over the last 5 years has been on South African supply concerns. But with the world economy recovering from the Sub-Prime Crisis and sales of automobiles exploding, the focus is likely to migrate toward economic prospects for China and India. 

The enclosed charts illustrate that palladium has two-thirds of its overall demand centered on auto-catalyst usage, while platinum has a much more diversified demand profile.

It is important to note that investment demand for both platinum and palladium is on the rise because of new investment instruments that have made it easier for smaller investors to gain ownership. Up until recently investment interest in PGM has been fairly insignificant, but if the pattern of annual world deficits continues, even marginal growth in investment demand could mean a serious tightening of supply.

Another factor contributing to volatility is that production is concentrated in a very few and sometimes unstable regions of the globe. Geopolitical uncertainties in nations like South Africa and Zimbabwe can threaten to reduce supply, but supply from other, more developed areas can also face interruptions. Prior to the Russia/Ukraine conflict, there was little concern about Russian palladium supply, but a harsh application of export sanctions against Russia could tighten global supplies even further, particularly to western markets.

Practical Strategies using Futures & Options

Since both options and futures are available for trade in platinum and palladium, traders and investors have the ability to obtain the leverage of being long and/or short futures contracts while defining or controlling their risk with offsetting option positions.

For example, those looking to remain long platinum for the final resolution of South African wage disputes (or those that want to be long for the brewing Zimbabwe government involvement in that country’s mining sector) could purchase October 2014 Platinum futures and look to protect those positions with just out-of-the-money put options. If the puts are too expensive, traders could also sell an out-of-the-money call option to help finance the cost of the put. However, those selling the call option should be aware of the risk of remaining short the call should they liquidate their long futures position.   

Other players might see palladium benefitting more from surging auto-catalyst demand than platinum. That is certainly evidenced by palladium mostly gaining on platinum (in contract value terms) since the beginning of 2008. Surprisingly, the setback from the Sub-Prime Crisis failed to hold back global car sales, and auto-catalysts have continued to be source of demand growth for PGMs. Some traders might continue to be long 2 Palladium futures against being short 1 Platinum contract.