Platinum Fundamentals

By: Scott Wright | Thu, Jun 29, 2006
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When I recently asked my wife what she wanted for our upcoming wedding anniversary, this was my first mistake. Then after she gave me her answer and I said I'd consider it, this was my second. "Honey, the gold on my wedding band is wearing a little and I've always wanted to remount my diamonds in platinum. Platinum is so pretty and it would be a nice contrast to all my other jewelry. And besides, after all these years of putting up with you, surely it can't be too much to ask."

Well for putting up with me she deserves an armored truck filled to the top with platinum bars, but in reality her "simple" request was quite precious. Platinum embodies the quintessential meaning of a precious metal. As one of the rarest metals in the earth's crust, its brilliance is reflected through its high price on the open market.

Measured by weight, platinum has been generally worth about twice as much as gold. And because of its rarity and beauty, it has taken the jewelry market by storm in the last century. Today platinum bullion coins are even recognized as a form of currency in many countries ramping up investment demand. It is just magical to hold in your hand a one-ounce pure platinum bullion coin. How can a goofy ring possibly provide the same feeling?

Platinum has a working side to it as well serving many different industrial applications. And in this growing global economy, platinum is not exempt from the economic woes that most commodities are currently experiencing. The balance of commerce is off kilter even for platinum as supply has not been able to keep up with fast-growing demand. Because of this imbalance, the price of platinum has substantially risen thus far in this still-young secular bull market in commodities.

As you can see in the chart above, platinum has risen right along side its more popular precious metal sibling, gold. Gold and platinum have carved beautiful uptrends as precious metals took the lead in this great commodities bull rewarding prudent investors and speculators with excellent gains to date.

Since the beginning of this bull market, platinum has gained over 200% and has amazingly shattered the four-digit level in price. It is incredible that one ounce of this very precious metal can be worth more than one-thousand U.S. dollars. And your wallet sure feels it when you outfit hand décor for the one you love.

As mentioned previously, global demand for platinum has soared in recent years. As you can see in the next chart, demand has steadily increased in each of the last ten years. Since 1996 there has been an incredible 35% increase in global demand for what the 16th century Spaniards dubbed "platina", meaning "little silver". If the Spaniards knew platinum's eventual value, they surely would not have discarded it as an unwanted impurity in silver.

According to the supply and demand data obtained from platinum group metals (PGM) think tank Johnson Matthey, there has been a running seven-year supply deficit in platinum. And analysts expect this deficit to continue.

Platinum demand has continued its global rise driven mainly by the autocatalyst sector. The growth of light-duty diesel vehicles in Europe has accounted for a large portion of this demand in recent years. And as demand for diesel vehicles continues to rise into the future mixed with tighter emissions standards being implemented globally, autocatalyst platinum demand should increase for many years to come.

In 2005 the autocatalyst sector accounted for nearly half of the global demand for platinum, using 50% more of the metal than just four years earlier. As newer model vehicles are manufactured to meet the latest emissions standards, increased catalytic converter production is ultimately what has been running up PGM demand.

Platinum has been the metal of choice in this sector due to its amazing catalytic properties even though all PGMs (ruthenium, rhodium, palladium, osmium, iridium and platinum) embody this characteristic with differing levels of efficiency. In a nutshell, PGMs serve as the catalyst inside a converter where the chemical reactions take place in turn treating vehicle exhaust emissions.

A growing global environmental push to reduce automobile emissions of particulate matter, nitrogen oxide and hydrocarbons has led to increasingly stringent EPA and Euro IV regulations. Vehicle manufacturers have to grin and bear it, but if you are a commodities investor and/or speculator this can be viewed in a different manner.

So with my commodities goggles on, I read this as catalytic converters should become mandatory in a growing number of vehicles globally in the future. And the more catalytic converters produced, the more PGMs will be required, specifically platinum. The more PGMs required, the more of a pinch PGM producers will face in bringing supply to market. And until the current economic imbalance reverses and there is a surplus of platinum, the prices will likely continue to rise. So going long platinum should be a no-brainer in this secular bull, right?

Well because of platinum's rapid price increase, there has been chatter in the automobile industry that an alternative needs to be found in order to cut costs. But since there currently isn't a good alternative to PGM catalysts in catalytic converters, other PGMs are being looked at as substitutes. Since the metals within the PGM class can indeed substitute for each another, with varying degrees of efficiency loss, there has been a shift to a higher ratio of palladium used as the catalyst in gasoline-engine vehicles.

Palladium, the second most popular and most abundant PGM, is currently about a quarter the price of platinum. Because it is so much cheaper and gasoline-engine catalytic converters don't lose their mojo with a higher ratio of palladium as the catalyst, it may be viable for manufacturers to look this direction. Some manufacturers are indeed making the move, but because of palladium's history of wild volatility, many of them have not jumped onboard just yet.

Interestingly, palladium is one of the few metals that is currently running at a supply surplus. For the fifth year in a row supply has been greater than demand. According to Johnson Matthey, nearly 8.4 million ounces of palladium was produced in 2005 while only about 7 million ounces was in demand.

One of the reasons for this palladium surplus is actually its decline in use in the autocatalyst sector over the years. As with platinum, this sector is also palladium's largest, but growth was flat last year. How can this be possible if palladium is starting to selectively replace platinum as an autocatalyst? Well one reason is technological advances which have allowed for increased thrifting of palladium in turn directly reducing its average load levels in catalytic converters.

Palladium is indeed being used in more and more catalytic converters, but mostly in gasoline-engine vehicles. With the increase in diesel vehicle production subsequently slowing the growth of gasoline vehicles, along with increased recycling and thrifting, palladium's perceived growth in the autocatalyst sector appears stagnant.

Where palladium demand has really picked up steam in the last few years though is in the jewelry sector. In just the last three years there has been a 450% increase in palladium jewelry demand. Its growingly popular stand-alone jewelry class mixed with its use as an alloy with gold to create increasingly popular white gold has fueled this increase.

Even with its growth in jewelry, you can see in the chart that palladium is trading below its early 2002 levels where most other commodities had taken off from. Overall a loser in this secular commodities bull, its bubble at the turn of the century spelled doom for palladium's current fortunes.

Since 2001 palladium has tanked from its high of $1,100 per ounce down to the levels we see today hovering around $300. Though many people place the blame on Ford Motors, the bubble spike you see in the chart above was really the result of two factors. Ford indeed played a large role, as revealed in its $1 billion charge in palladium losses a couple years ago. The reason for this was Ford irrationally stockpiled vast quantities of palladium in 2000 afraid that Russia would halt its supply. This in turn tightened supply and really ended up biting Ford along with the entire palladium market.

But the other factor was the little known Coltan Crisis. At the peak of the tech bubble, palladium was deemed the replacement for the then short-supplied tantalum, used in various electronics as well as cell phones. This crisis ended up being blown way out of proportion, but the two combined factors prompted speculators to emphatically bid up palladium prices leading to its sharp crash in 2001 that I believe this metal has still not yet fully recovered from.

As implied, Ford's fears ended up proving wrong as Russia is a prime culprit for palladium over-supply. But its vast palladium stocks will significantly decrease over the next couple of years and demand for palladium should continue to rise. Industry experts forecast demand will eventually catch up with supply and that perhaps a supply deficit might rear its head as early as next year. Palladium should be an interesting metal for investors and speculators to keep an eye on in the years to come.

Even with the palladium autocatalyst prospect looming in gasoline-engine vehicles, diesel vehicle growth, focused mainly in Europe right now, might perhaps be able to continue to hoist platinum demand on its own. As mentioned before, European diesel vehicle growth has been the main factor in the growing platinum demand. The reason for this is up until recently, platinum had been the only metal used in the compression-ignition engine catalytic converter.

Diesel emission control is tightly regulated in first-world countries, and in order to meet the high-temperature permanence in diesel engines, only the platinum catalyst possessed the acceptable physical and atomic properties. And with the increasing need to focus on reducing nitrogen oxide and particulates (soot) from diesel engines, platinum, which is the most active catalyst, has been the only option in meeting environmental regulations.

Recent technological breakthroughs have enabled palladium, which actually has the lowest melting point of the PGMs, to substitute for a minor portion of the platinum within diesel catalysts. This is not enough to significantly curb platinum demand, but every penny saved in auto manufacturing is meaningful, so it is being welcomed by manufacturers with open arms.

And with diesel vehicles proving to be more energy efficient than conventional gasoline-engine vehicles, the case for platinum really heats up. Europeans pay about three times as much for gasoline as Americans do, so the incentive is there to streamline energy efficiency. Nearly half the passenger vehicles sold in Europe now have diesel engines, and this is expected to grow.

Gasoline costs in America are not high enough yet for consumers to take action, but when prices do rise enough, will diesel make a comeback in the U.S.? I'm not advocating diesel over gas, but many of the problems with diesel vehicles in the past have been overcome, so you never know. Either way, the autocatalyst sector will continue to dominate PGM and specifically platinum demand.

And whether diesel or gas, thankfully it is quite difficult for the average person to access catalytic converters in vehicles. Most people don't normally consider that when they park their newer model cars on the street, they are exposing one of the rarest and most expensive metals on earth. At today's prices, a sophisticated thief could make a fortune if he figured out how to quickly and easily extract platinum or even palladium from catalytic converters.

With copper prices on the rise, thieves today are raiding construction sites and abandoned warehouses to steal wiring and tubing to sell for some gain. Site foremen are now forced to lock up their copper overnight to prevent this. If a thief is willing to take this risk for something worth less than one ten-thousandth of one percent the value of platinum measured by the ounce, then you never know. I know this is pretty much impossible, but nuttier things have happened. Hmmm, you are probably thinking by now that my wife actually deserves two armored trucks full of platinum bars huh?

Back to platinum fundamentals, the next major sector that consumes platinum is the jewelry sector, which commands about one-third of platinum's annual demand. But surprisingly this sector has seen a sizeable decrease in demand over the years. There has been an incredible 30% decrease in jewelry demand for platinum in just the last four years.

With the high price of platinum these days, as I well know, jewelry consumption has been down from a mere affordability standpoint. Instead of placing new orders, jewelers have been depleting stock and recycling consumer-sold metal. And surprisingly another big reason for jewelry decline last year was Chinese lore. Last year was the Year of the Rooster, in which it is traditionally a bad year to get married. 2006 is the Year of the Dog, and weddings are expected to skyrocket in China significantly increasing jewelry demand, with platinum not being an exception.

And with platinum's high price, white gold and palladium have seen a surge in the jewelry sector as a platinum substitute. Though there are core differences, to the naked eye they look virtually the same as platinum, and are much cheaper. Upscale jewelry buyers are not expected to sway from platinum though regardless of the price, and neither will my wife.

The only other industries that have a significant industrial use for platinum is glass and electrical. The glass industry is seeing fast-growing platinum demand led by its use in LCD and various flat panel displays. And demand is quickly growing in the electrical industry as the development of fuel cells continues to rise with platinum playing an important role.

Geopolitically 90% of today's mined platinum supply comes from two countries. And South Africa alone produces the lion's share of this amount as it produced over 5 million ounces of platinum last year. South Africa is expected to continue to be a major PGM supplier in the years to come, but with the strength of the rand against the dollar and the growing risk its Marxist government poses, it is not the safest place in the world for it to be coming from. Russia is the other major platinum producer as the giant Russian nickel and copper mines are finally releasing this valuable byproduct to the open market.

Platinum is a fun metal to analyze, but the underlying reason we do this is to identify opportunities to make money on it. Fundamentally platinum is poised to continue its rise in this secular bull market, but how do we trade it today? Gold and gold stocks have captured much of our attention on the precious metals front, so how does platinum compare?

First, gold is my absolute favorite precious metal. Its characteristics are unequalled compared to all other metals and it serves as the best overall store of value especially in this day and age as a hedge against weakening fiat currencies. Even though platinum is more of a precious metal on the value front, due to the sheer fact that the world's supply of platinum, annually and historically, is insignificant to hold as a global currency, it will never replace gold as the ultimate precious metal.

Gold can be very useful in trading platinum though. Gold and platinum have had an amazing correlation in this bull market of 0.958 with an r-square of 92%. So 92% of the daily behavior of platinum can be statistically explained or predicted by gold, not bad. We use many technical trading tools for timing our tactical and strategic gold trades, so these should be useful for platinum as well.

One of the tools we use is Relativity. Relativity is a trading theory my partner Adam Hamilton developed years ago in order to help us better understand and time the flows and ebbs of secular bull markets. The simple mathematics of Relativity are measured by dividing the price of in this example platinum by its 200-day moving average. Charting the resulting data provides a relative trading range for platinum as a constant multiple of its 200dma over time.

The chart above provides a probabilistic trading band showing when odds favor a surge or correction at any given time. As you can see, the horizontal relative support and resistance lines have provided us with fairly good and reliable entry and exit points for platinum. Since 2002, there have been three notable uplegs in platinum. And in each of these uplegs, relative buy signals allowed us excellent entry points and relative sell signals allowed us to capture a large portion of the gains before the following correction.

After this latest upleg that screeched to a halt in May, platinum has been correcting sharply with all the metals as the wild euphoria was finally unmasked. This correction was very necessary though in order to bleed off greed and balance sentiment so new momentum can be built for the next upleg in this secular bull.

So as we wait for our next opportunity to deploy near-term speculative capital into not only gold, silver and base metals, we need to identify our targets for the PGMs as well. Speculators have been able to ride platinum for large part in the futures markets. But thankfully stock investors and speculators have stellar opportunities as well in the companies that explore, develop and produce PGMs as they are typically well-leveraged to ride platinum's gains.

Platinum has a relatively small market compared to most other metals. As an example, the largest gold producer in the world single-handedly produced more ounces of gold last year than the entire global mined supply of platinum measured by weight. Opportunities still exist though and even though platinum stocks are not as abundant as say gold stocks, there are several good ones out there.

And so far history has revealed the time to buy PGM and platinum stocks is when the underlying metal is trading near its 200dma as indicated by Relativity. When platinum is at its relative support, probabilities favor an upleg in continuation of its upward secular trend. In the subscriber section of our website we update a large rPlatinum chart weekly among the dozens of charts we use to analyze the markets and time our trades.

As we watch platinum's technical signals as well as monitor the behavior of its shiny yellow brother, gold, we are researching the best of the best metals companies that are likely to thrive in the upleg to come. On the Watch List in our monthly Zeal Intelligence newsletter, we list several PGM candidate stocks among the many we are tracking in addition to over 50 other commodities stocks that we favor as buying opportunities present themselves.

If you wish to get cutting-edge commodities market analysis and stock picks as well as access to our acclaimed charts, please subscribe to our newsletter today. New email subscriptions will receive a complimentary copy of the current issue.

In addition to platinum, we will also continue to keep an eye on palladium as this bull gallops forward. As demand increases and warehoused stock decreases, a potential imbalance may be approaching in the near future. Palladium may indeed join the commodities bull run before it is over.

A late bloomer is perfectly acceptable in any normal secular bull market as not all commodities are required to join the party at the same time. Base metals lagged precious metals and energy by a couple of years in their bull run and perhaps palladium will find some momentum soon to come.

The bottom line is as we trade the commodities bull, our strategy is to buy the stocks of the companies best leveraged to take advantage of an appreciation of their underlying commodity. The companies that explore, develop, produce and service commodities have been some of the best performers in recent years.

At Zeal we have had great success trading the metals and energy stocks. PGMs will offer similar opportunities. And though this market is small, fundamentals tell us its bull is likely far from over.

 


 

Scott Wright

Author: Scott Wright

Scott Wright
Zeal LLC.com

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