Oxstones Investment Club™By Andrey Dashkov, Casey’s Research,
Platinum – sometimes called “the richer man’s gold,” has been generating a lot of buzz lately. Historically platinum has sold for more than gold, but today it’s selling for considerably less than gold. Is this an anomaly worth betting money on? Or have market forces changed, causing a shift in the apparent price relationship between the two? To attempt an answer to these questions, let’s have a look at platinum fundamentals.
Supply
South Africa tops the list of producers with 74.7% of global production (4.8 million ounces in 2011) and 95.5% of known reserves. Russia is a distant second with 825,000 ounces produced in 2011 and 1.7% of known reserves.
With so much of the world’s platinum production controlled by one country, the question of supply stability is extremely relevant. South Africa’s aggregate Policy Potential Index ranks it 67th out of 79 countries in the Fraser Institute’s 2010/2011 Survey of Mining Companies report. For mining companies, South Africa is challenging in at least two ways: It faces power shortages that the country’s state-owned power utility says could last five years; and increasing labor regulations and costs have compounded the infamous miners’ strikes t hat have been in the news recently.
Structural weakness in South Africa can seriously endanger future mine supply of platinum, even without the sociopolitical situation in the country getting worse. The prognosis for South Africa looks grim, but that same factor is bullish for the price of platinum.
Hurdles like these, however, do not impact its secondary supply. More efficient methods for recovery of platinum from used automobile catalytic converters added about 1.9 million ounces to world supply in 2011 – 29.4% of the total and 3% higher than a year ago.
Overall, platinum supply has remained largely flat in the past several years, but some analysts predict shortages. If those materialize, they should lift the price. But this argument rests on the assumption that the economic outlook for the global economy is positive and keeps the demand – largely for autos – climbing while supply remains constrained. Platinum demand for use in catalytic converters in cars rose by a mere 2.8% in 2011- that’s a very small increase in the single highest-use application for the metal compared to the 40.7% annual growth recorded in 2010 – which itself came after the much weaker economic times of 2009.
The opinion that platinum supply won’t keep pace with expanding demand was quite popular last year, but some independent reports call for a tight balance with a tendency toward a surplus. According to Johnson Matthey’s Platinum 2011 Interim Review, for example, the sector produced a 195,000-ounce surplus in 2011. Total supply increased by 6% to 6.4 million ounces.
Another take on the numbers from the CPM group in their CPM Platinum Group Metals Yearbook 2011 is presented in the chart below.
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The CPM data show a current surplus in the platinum market. The 2011 data are estimates but are likely to be reasonably close. The peak year for platinum usage during the late 2000s was 2007, which saw a significant deficit, though not as great as in the late 1990s. The deficit shrank in 2008 as global economic growth slowed. In 2009 and 2010, the market showed a surplus. The overall trend since 1997 has been a shift towards surplus.
As a side note, if one didn’t know that other precious metals had increased in price from 2000 to present as platinum has in the chart above, one might conclude from the chart that the great supply deficits of the late 1990s and early 2000s were what sent platinum prices up so sharply. And maybe they did – at least to some degree, since few people think of platinum as a monetary metal or can even tell platinum from any other silvery metal. But to whatever degree this is true – that supply deficits lead to higher prices – the current supply surplus is a very bearish indicator.
Industrial Demand
Catalytic converters in cars convert toxic emissions into nontoxic substances, and platinum is a key element in how they work. As above, demand for catalyst production rose by 2.8% in 2011 to 3.2 million ounces. This is significant growth but remains below the 4.1 million ounces consumed in 2007.
The key question is: What are the chances that platinum consumption, especially in the auto sector, will return to pre-crisis levels?
We are not experts in the auto industry, but it’s something that moves in step with the global economy; here at Casey Research, we consider rosy industrial growth projections for the coming years to be seriously questionable. Current events from two heavily indebted regions – Europe and the US – make a case for a negative medium-term outlook for many industries, including the automotive industry. Numbers from China are not optimistic either: December car sales figures from China Association of Automobile Manufacturers point to waning passenger-car demand. That is very bearish for platinum demand.
Further, as global economies slow or continue stagnant and troubled financial institutions and governments teeter closer to the edge, we could be headed for another 2008-style financial crisis. If that happens, there’s no question that prices for industrial metals, including platinum, would get hammered.
Moreover, as platinum rose, research began looking for cheaper alternatives. Palladium has increasingly been used as a substitute in industrial applications, mainly in autocatalytic systems. This expanded use of palladium has increased its total demand, resulting in a dramatic price rise since 2006. However, a large price gap between palladium and platinum remains, meaning that incentives to find more ways to use it as a platinum substitute remain strong. You can see this in the next chart, which shows the difference between palladium and platinum demand trends.
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Palladium was not hit as hard as platinum in 2008, and its overall demand is larger, partly because it took a larger share of use away from platinum through substitution. However, palladium substitution in diesel engines has proven more difficult, and diesel-engine cars are growing more popular in Europe – they account for about half of all cars bought in 2010. The car market in Europe – one of the largest platinum markets – remains an outlier regarding engine preference as gasoline engines still dominate the other significant car markets. See the chart below.
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The next chart shows that although the general trend for diesel-powered cars is to gain market share, the increase is quite moderate year over year, and in times of financial or economic crisis, their share drops. One reason may be that, though diesel-engine cars tend to last longer, they also tend to be more expensive up front.
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Although in 2010 diesels regained several percentage points lost in 2009, they have yet to beat the 2007 peak that coincided with a platinum deficit that same year. Diesel engine adoption may thus be one of the most, if not the most important component of the global platinum demand picture.
However, the dominant use of platinum in catalytic systems in the diesel-engine market may be changing soon. According to a report from platinum-group metal producer Stillwater Mining Co. (SWC), palladium could capture up to half of the existing platinum demand in diesel catalytic systems:
In the early 2000s, when diesel engine emission treatment technology was being considered, scientists had concluded the low-temperature diesel emissions could only be treated using platinum. Subsequent research, driven by the same fundamental economic driver – i.e., cost – demonstrated the feasibility of using some palladium, and then increasing levels of palladium, in diesel engine catalytic converters and diesel particulate matter filters (DPF). By late 2009, technology had emerged reportedly allowing palladium to displace up to 50% of the platinum loadings in diesel catalytic converters, and with the technology in hand, movement toward 50% palladium loadings is now underway. This is a significant development considering over 50% of new European-built cars are diesel and considering diesel catalytic converters require two times more PGMs than equivalent gasoline engines.
A shaky economic outlook coupled with technological advancements that allow for growing substitution of palladium for platinum in diesel engines make us believe that the industrial demand for platinum will not accelerate anytime soon, if ever.
Investment Demand
Understanding investment demand for platinum is tricky. The metal lacks the safe-haven-status track record or monetary history of gold, yet it has precious-metal status and has been more expensive than gold, leading some investors to believe it is a good – if not better – store of value than gold. David Wilson from Societe Generale, one of the most accurate platinum price forecasters according to Bloomberg, opines on why that’s not the case:
“Fear drives gold, and at the moment there’s a lot of fear. … Gold is far more of an investment metal, a speculative metal and a safe haven. Central banks buy it as a store of value and it’s a proxy currency. Platinum isn’t any of those things.”
However, there is an investment market for platinum, represented mainly by the physical metal-backed ETFs, shares of mining companies, and the physical metal itself. It’s a small market: All physical-backed platinum ETFs held about 1.3 million ounces as of November 1, 2011. Compare that to 73.3 million ounces of gold held in all gold ETFs, or 559.4 million ounces in silver ETFs, both as of the same date.
Investment in the physical metal has not gained any significant momentum worldwide; and in 2011 global investment demand for platinum decreased, as the following chart shows.
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Most notably, investment demand decreased in the North America, from 465,000 ounces in 2010 to 65,000 in 2011. In general, the physical market for platinum is still pretty small and illiquid.
Global investment demand is estimated to have dropped by 24.4% in 2011. A mania – if there ever was one or if we’re headed into one – wouldn’t look like this.
So is it time to get on board and buy platinum? Some say it is, partly because gold has been losing its luster recently.
Platinum vs. Gold
Many market commentators are on record as claiming that gold is in a bubble. When it comes to platinum, one of the bullish arguments in favor of the gray metal is that it is more scarce in nature than gold and thus more precious.
This is a misconception. In the Earth’s crust, where current technology allows for the economic mining of metals, platinum is more abundant than gold by every single estimate. On average, gold is estimated to exist in concentrations of 0.0011-0.004 parts per million (or grams per tonne) and platinum at 0.003-0.005 ppm. These numbers may be eye opening for some, but we do not imbue metal ratios with market-prediction power. They represent fundamental supply on a scale that is not necessarily relevant to current market conditions. And the relative rarity of a metallic element in the Earth’s crust is not the same thing as the relative rarity of economic concentrations of that metal in exploitable locations.
Much more influential is the current turbulence in the North American and European markets, two significant consumers of cars and hence platinum. The governments in both areas are focused on boosting economic growth with spending stimulus and run the risk of boosting inflation and lowering living standards. This could result in falling demand for cars, even if paper money is more abundant.
Much of the opinion that the platinum price will rise is based on the expectation that the global economic problems will be solved very soon. To us, that seems highly unlikely.
Conclusion
Platinum is a precious metal and as such was considered by some to be a worthy challenger for the safe-haven status of gold (and silver). Some say that physical platinum and investment instruments backed by it will outperform gold in the coming years. This notion is based on the assumption that gold, despite the current correction, is overpriced and will see limited growth at best, while the platinum market fundamentals allegedly support a deficit scenario that, coupled with new investment demand, will drive its price higher.
The following counterarguments make a negative investment case for platinum:
- Platinum is largely an industrial metal and as such is a cyclical asset that appreciates in times of boom and goes down when industrial growth slows.
- Platinum does not have the status of being either money or a safe haven that gold and silver have.
- The consensus opinion here at Casey Research is that the United States is entering a severe depression. The outlook for heavily indebted Europe is not positive either. These two are the largest platinum markets, so the direct implication for the metal is slowing demand.
- The metal is rare but not more so than gold.
- Due to a high platinum price, palladium substitution continues to make inroads into processes where platinum currently dominates.
- CPM Group’s numbers project a surplus for 2011, not a deficit.
- With the questionable perception of a looming shortage factored in, platinum looks expensive.
What does it all boil down to for potential platinum investors? We generally recommend avoiding South Africa, and in this context that means staying away from platinum producers located there. If the energy situation spins out of control, miners’ strikes continue, and the local trouble puts an indefinite halt to a significant portion of platinum production, some speculative opportunities may appear in the physical-metal market or platinum-backed investment tools. If we see signs of that happening, we may speculate on the results – but anyone who wants to play that card will likely have to be prepared to act very quickly. For now, absent such a major disruption in supply, we are not bullish on the metal or the companies focusing on it.
Tags: auto, base metals, car market, catalyic converters, commodities, disel engines, gas engines, gold, industrial metals, palladium, platinium etfs, Platinum supply, russia, silver, south africa