Special Report: How to Invest in Palladium

A quick heads up before we get started with today’s report. If you should happen to be in the Scottish neck of the woods this August, I am doing one of my lectures with funny bits at the Edinburgh Fringe this year.

This one is about gold. It has got Greek gods, heists, interstellar collisions and Nazis. What more you could want in a show? Except possibly Vikings, I’m not sure.

It’s from August 4th to 20th at 2pm - some highbrow mind food with which to start your day. Please come if you are in town- you can get tickets here.

Plus it’s in the room in which Adam Smith completed Wealth of Nations.

Here’s the blurb:

Older than the solar system itself, gold has captivated humans since the Stone Age and driven them to do the most extraordinary things. But does it have any future in this digital age?

A lecture with funny bits by financial writer / comedian, Dominic Frisby about the amazing metal that is gold.

The Times say Dominic is 'outstanding'. The Telegraph says he’s 'excellent'. The Spectator says he is 'mercurially witty'. Even The Guardian admits he 'can be entertaining'.

Hopefully, I will see you there.

Right, palladium …

Amongst other things, this piece contains an update on our top PGM pick, with whom I met last week.

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Please do not share, copy, reproduce or distribute any part of this report without the express permission of the author.

“Palladium” as imagined by Midjourney

Most metals, whether precious or base, tend to trade as a herd. If copper is rising, zinc probably is too. But palladium is very much its own animal. Never mind the herd, it strikes out and does its own thing. Not always, but often.

In the late 1990s, for example, when most metals were at the tail end of a bear market that had gone on for 20 years to become one of the worst in history - palladium launched on a four-year run that saw it rise 1,000%. It went from $100/oz all the way to $1,100/oz by 2001. The likes of gold and copper were declining over the same period to 20-year lows

The reason was that auto manufacturers switched from platinum to palladium for their catalytic converters. Changes in fuel meant the advantage of platinum was negligible. Palladium was more efficient at reducing hydrocarbon emissions and much cheaper. But the switch then met with disruptions to exports from Russia, the world’s largest producer. It became known as “unobtanium” and the price rocketed.​​

But then, between 2001 and 2004, when the bull markets in gold and copper were just getting going, palladium then lost 85%. The market is thinly traded, while stocks are minimal, meaning it can be prone to big price swings. When gold and copper had their day in the sun in the lead up to 2008 and 2011, palladium was a bit “meh”. It rose, but not by nearly as much, and the highs were nothing like those seen at the turn of the century.

Echoing the 2000-2001 bull run

If you’re one for fractal patterns (trades that repeat themselves, the chart of X now looks just like the chart of Y in 2003 which means Z is about to happen) then you’ll like what’s been happening with palladium since late 2015.

Over the next four years it made a similar run to its move at the turn of the century. It went from $450/oz all the way to $3,000 in 2021. Last year, as a certain Mr Putin invaded Ukraine, the price spiked briefly to $3,425. The chart action - a classic “three drives to a top” - was eerily similar to the “three drives to a top we got in 2000-2001.

It has since fallen by over 60% to $1,400, where it sits today.

The reason for its recent run was not unlike that at the turn of the century. It begins with the Volkswagen diesel scandal of 2015 when it emerged that Volkswagen, and probably many more carmakers besides, had been understating the pollution emissions of their diesel engines.

“Dieselgate” led to a sea change in attitude towards diesel, especially in Europe. People no longer wanted diesel cars. Governments didn’t want people driving diesel engines, so they raised taxes on them. Legislation changed and now the demand was for cleaner electric, petrol and hybrid alternatives. 

Diesel vehicles’ catalytic converters rely on platinum. When sales collapsed, so did platinum. But sales of petrol-fuelled cars, which use palladium in their catalytic converters, increased and the new emissions regulations led carmakers to use more palladium. Then Putin invaded Ukraine, and supply disruptions followed. Palladium has been, in many ways, a regulation play. Will public opinion towards diesel change? Will regulation change? It looks unlikely.

What I like is this: an epic bull market in palladium at the turn of the century anticipated the memorable bull market we saw in the 2000s for other metals.

One hopes that the bull market we have just witnessed in palladium anticipates a similar run for metals. Cripes, the fundamentals are there in spades: years of underinvestment, increased demand (this time because of net zero) and a lot of money floating about looking for a bull market. Nevertheless palladium, not other metals, is the focus of today’s article.

Named after an asteroid

Palladium is a not-so-well-known, lustrous, silvery-white metal. It was only discovered in 1803, by an English chemist, who named it after the asteroid Pallas. It is categorised as a platinum-group metal (PGM), but it has the lowest melting point and is the least dense of them.

Its predominant use is in catalytic converters for cars, which convert as much as 90% of the harmful exhaust fumes into non-toxic substances. Catalytic converters account for around 80% of annual demand (excluding investment).

The rest comes from electronics (it is used in ceramic capacitors in phones and laptops); jewellery (mostly as an alloy in white gold); dentistry; and the chemical industry (as a catalyst to separate hydrogen).

Should the hydrogen- and fuel-cell economy ever take off, and there are signs it might, palladium should benefit. It is a key component of fuel cells, in which hydrogen and oxygen react to produce electricity, heat, and water.

Annual demand is about 9.35 million ounces. Having risen from seven million just a few years ago, it is forecast to rise to ten million next year. To put those numbers in perspective, annual demand for silver is one billion ounces, and annual demand for copper is 24 million tonnes (there are over 35,000 ounces in a tonne). It’s a niche metal, in other words, and a small market.

In 2022, 83% of the total demand for palladium worldwide came from the automotive sector: 8.4 million ounces of metal. Demand from other industries reached 1.6 million ounces, while demand in jewellery was just 93,000 ounces.

Two key sources of supply

China is the world’s largest consumer, followed by Europe. China required 2.3 million ounces of palladium last year – a number, interestingly, that was north of three million in 2019 and 2020, so it has decreased.

Palladium is traditionally seen as a cheaper alternative to platinum, although the evidence of the past few years is that this view is baloney. A couple of years ago, palladium was more than three times the platinum price. Extraordinary. But the ratio between the two has been falling hard and fast. We appear to be reverting to the mean.

I have to say: of the two, I still prefer platinum, even after the recent run. There is still some way before the mean reversion is complete. Historically, platinum is the more expensive.

If you look at the long-term ratio of the two metals, you will see that it is not abnormal for palladium to be one or two fifths of the platinum price. Yet currently platinum, which sits at around $1,100/oz, is some 20% cheaper. Palladium is at $1,400.

The gap between the two is closing fast.

Looking at palladium vs gold, you can also see that palladium is still expensive, even with the price having come down a lot this past year.

An extreme short position

That said, there is a compelling reason for palladium in the short term. Charlie Morris of Bytetree alerted me to this in a recent missive. He writes: “What is extraordinary, and something I have never seen before, is how the financial services industry has a negative holding in palladium. That is, their combined holdings in the ETFs and the futures is net short by 0.277 million ounces.”

The futures longs are extremely low. The shorts are abnormally high. The ETFs have been declining for years. The net result is a negative holding. “The financial services industry cannot be physically net short, and so they must presumably cover at some point,” he says. Covering means buying pressure, though for now the short position has been dominant.

As I say: palladium is thinly traded and stocks are minimal, so big price swings can follow. If we get a short-covering rally, it could be a big one. 

While the price had been in freefall, since March things appear to have stabilised a little.

Ways to invest in palladium

So how to play all this?

As with gold and silver, there are two main ways to play the palladium story.