Palladium is a valuable metal due to its existence within the Platinum Group Metal (PGM) group as well as its industrial use. The demand for palladium is mostly derived from the catalytic converters in petrol and hybrid car engines, which represents that palladium prices is contingent on the strength of the automobile industry. Major players in the palladium industry include Anglo American Platinum, Sibanye-Stillwater and predominantly Norilsk Nickel (Nornickel). Nornickel dominates the market with a 40% global market share in palladium as well as being the industry’s lowest cost producer. Based mainly in Russia, it supplies products to 37 countries.
Recently, between 2017 and 2019 the average quantity of precious metals used in catalytic converters rose by more than 25%. This has been fundamental in driving the palladium price rally which peaked in February at highs of $2880 an ounce after rallying by over 100% within the past 3 years. Some investors feared the potential threat of automakers substituting the use of palladium to platinum, but given that it can compromise the performance of the catalytic converter and it is a long-term adjustment, it is unlikely that this transition will fully materialise. Indeed, the supply deficit has only increased in recent years following the introduction of new, tightened emission standards like ‘Europe 6’ and ‘China 6’, which in turn has necessitated increased use of palladium in vehicles.
The impact of COVID-19
Initial bullish expectations for palladium were weakened by the onset of COVID-19, which facilitated a demand shock in the automobile industry. Supply was hit when South Africa’s PGM producers were heavily disrupted, including Anglo American who declared force majeure in March after an explosion which led to palladium production being cut by 30,000 ounces. Exacerbating this was a decline in flights available from March to April, which resulted in metal shipments experiencing severe disruptions.
However, the largest impact was seen with demand, whereby demand for new vehicles fell by 47% across the EU and companies such as Johnson Matthey – leading catalytic converter producer – axed one-sixth of workforce amidst of the pandemic. The effect is evident if you look at the global palladium consumption this year which is seen at 10.6 million oz in comparison to its forecasted value of 11.5 million oz. As a result, prices fell to $1619.14 per ounce and falling car sales have created expectations of a balanced market for the first time since 2011. Furthermore, this has harmed the leading palladium mining companies where both Anglo-American Platinum and Impala Platinum have cut production targets due to COVID-19.
Supply squeeze and demand vacuum
The unfortunate emergence of COVID-19 had concluded palladium’s remarkable run. Just one month before the WHO officially declared COVID-19 as a global pandemic, palladium prices surged by 270% over five years to a record high of $2,880 an ounce and overtook gold for the first time in 16 years. But economic stagnation has created a daunting demand vacuum that would inevitably erode investors’ confidence in palladium.
Today, the automobile industry accounts for over four-fifth of global palladium demands. Car manufacturers rely on palladium to make auto-catalysts and emissions purifiers for petrol/gasoline engines. However, Q1 2020 witnessed the steepest drop in global car production since the 2008 Financial Crisis as production dropped by 30%. But apart from COVID-19, China’s decision to extend its subsidy scheme for New Energy Vehicles (NEVs) to 2022 will also contribute to the fall of palladium demands because auto-catalysts and emissions purifiers are not needed in electric cars.
To accommodate China’s desire to accelerate electrification in the public transport sector, the Chinese government introduced two major environmental regulations to incentivise its citizens to purchase electric cars: first, subsidy scheme. For Chinese citizens that are looking to purchase electric cars that cost less than 300,000 yuan (£32868), they will be eligible for state-sponsored financial aid. Second, purchase tax exemptions. Ministry of Finance has announced that starting from 2021, electric cars will be exempt from the 10% purchase tax.
In addition, the recovery of palladium supply is creating further downward pressure on palladium prices. South Africa, the 2nd largest palladium producer in the world, is allowing its mines to restart at up to 50% capacity from April 2020. A 3.6% fall in palladium prices in Q2 2020 demonstrate that the rate of supply recovery outpaced the demand recovery.
In light of China’s eagerness to improve its green credential and the gradual recovery of palladium supply at South Africa, it is unlikely that palladium prices can bounce back to the $2800 an ounce peak in 2020. Nonetheless, with automobile factories across China, US, and Europe beginning to re-open, palladium prices can return to $2400-$2600 per ounce in Q4 2020 if global palladium demands can break through the 10 million ounces barrier (palladium demands in 2019 was 10.88 million ounces).
A balanced market
Despite the South African government allowed mines to re-open, analysts from the Bank of America predict that it will take South Africa at least 6 months to take palladium production back to pre-coronavirus level. Supply disruptions at South Africa and the fall of global car production has caused a collapse in both palladium supplies and demands, which in turn created a (relatively) balanced market.
(Source: Trading View, RSI indicator on Palladium USD/Ounce)
RSI is typically used for determining the growth potential of a market by identifying the overbought and oversold level on a scale of 0 to 100. Hypothetically, if it reaches above 70, it indicates that the commodity in issue has risen a lot in a short period of time and the commodity may be subjected to a cyclical slowdown. On the other hand, a score below 30 represents that the commodity in issue has fallen rapidly despite positive market signals, which indicate that the commodity may see a rebound soon.
Intriguingly, palladium did not exceed the critical ‘70’ threshold nor fell below the ‘30’ limit. During the first half of 2020, palladium recorded a modest range of 51.20 to 63.27, which demonstrates that the palladium market has been broadly balanced by equilibrium forces. Such forces play a vital role in avoiding a huge mismatch between supply and demand in the palladium market.
A key driving factor behind this balance is the limited accessibility and availability of palladium. Although South Africa has resumed its mining operations, the amount of palladium available in the market has always been consistently low because (1) there is less palladium being mined today than in 2004 (2) the above-ground stocks of palladium have declined by 5.3 million ounces since 2010. Given that the palladium market is characterised by low stock level and low inventory level, any evidence of a pick-up in demand could inspire another astronomical rally.
Palladium prices and the development of electric cars share an inversely proportional relationship – the rise in popularity of the latter would in turn decrease the value of the former. In order to monitor the development of electric cars in China, investors must pay close attention to China’s subsidy scheme. Recently, media outlets like Thomas Reuters are reporting that foreign automobile brands are struggling with the eligibility requirement of the subsidy scheme because the price of their electric cars exceeded the 300,000 yuan threshold.
Take Tesla as an example, its Model 3 sedans are currently priced at 323,800 yuan, which means that Chinese drivers who wish to purchase the Model 3 sedans would not be eligible to receive financial aid from the government. Thus, whether the Chinese government is willing to change its eligibility requirement to accommodate foreign automobile brands would definitely affect the sales and popularity of electric cars at China.
Supply squeeze: Typically used to explain how market pressure can influence the profitability of a commodity. For instance, during recession, it would be more difficult for investors to make profit because of the ‘high supply – low demand’ dynamic.
Demand shock: A sudden change – an increase or decrease – in the demand for goods or services.
Demand vacuum: A rapid decline in demand caused by recession, economic stagnation, and/or low market confidence.
Subsidy scheme: A financial aid programme extended to multiple sectors within society for the purpose of promoting new economic policies.
Cyclical slowdown: The risk of economic boom-bust cycles creating a negative impact on the potential growth and return of an investment.
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