Sunday, January 11, 2009

Precious Metal Fundamentals - Recent Developments

We live at a time where information, as well as ENTROPY, spreads at light speed. We must be able to use our own intelligence to discriminate and filter out the noise from the internet, otherwise the internet is nothing but a giant trash can. In this world with little trust left in the system, we can no longer trust the authority of any information source. Mr. Bernard Madoff has proven that higher authorities CAN tell much bigger lies for much longer time. Everything we hear must be scrutinized using facts, logic and reasoning. I spotted an internet fraud and developments so far proved me completely right.

Recently Mazda repeated its claim of their single-nano catalyst technology which cuts usage of PGM metals in vehicle catalytic converters by up to 70%. Their technology uses smaller PGM particles and a proprietary agglomeration prohibition material. As a PGM metal investor I always pay close attention to such news that may bring change to the PGM supply/demand fundamentals. So how much can we believe in Mazda's claim and how soon do we expect an impact on the PGM metals demand?

History is the best teacher! In 2002, Daihatsu, announced that they invented a perovskite based Self-Regenerating "Intelligent Catalyst", which dramatically cut PGM metal usage while making the catalytic converters more durable. The idea was pretty good. Frankly the 2002 Daihatsu claim was much more credible than today's Mazda claim. There were independent researches on the perovskite based self-regenerating catalyst at the time. Now six years later, where is Daihatsu's "smart catalyst" today? Has it leads to any reduction in autocatalyst consumption of PGM metal? Not a zilch! If Mazda's idea of reducing metal particle size could work, it would have been tried long ago. My physics background allows me to conclude confidently that the so called single-nano technology CAN NOT work reliably and durably. I do not believe it until they get an EPA approval.

I am not saying that Daihatsu or Mazda made false claims. But scientific researches and commercial applications are two different worlds. In reality, 99% of research advances never make it into commercial products. Those few that do make it into the commercial world, take a long time to get there, and could still be ultimately rejected by the market, for non-technical reasons. Inventor Thomas Edison got cold water poured over himself when he tried to patent one of his first inventions, a voting machine that can precisely tally up voting results. Why we struggled with hanging chads in 2000? Politicians would rather prefer Diebold.

Why recent PGM thrifting news only came from small Japanese auto makers like Daihatsu and Mazda, but never from bigger names like Toyota Motor (TM), or Johnson Matthey, who is responsible for 1/3 of the world's autocatalytic converters? Mazda is NOT setting its priorities right. Each catalytic converter contains about 4 to 5 grams of palladium, worth about $24 at today's price. How can they cut corners and sell vehicles with sub-quality parts to customers? There were so many complaints about defective catalytic converters that even EPA had paid attention. You think consumers will let you get away with it?

Auto makers should boost the palladium content in catalytic converters and make them reliable and durable. Green cars with reliable emission control should then be exempted from the costly ($60+) annual SMOG tests in California and other states. Consumers will welcome the saving of money and hassle as it is worth far more than the extra cost of PGM metals.

I am convinced that the bullish fundamentals of palladium are even better in 2009. Recently Impala Platinum (IMPUY.PK) updated their estimate of platinum and palladium supply/demand data for 2008. Notice the significant drop of Russian supply? The annual sale of Russian Strategic stockpile palladium, about 1.5M to 2M ounces a year, finally ENDED! Back on June 11, 08, the palladium market knee-jerked when Norilsk Nickel (NILSY.PK) merely suggested the termination of the stockpile palladium sale. Now it really ENDS, how will people react when it becomes widely known? Russia maintains a Defense Strategic Stockpile for its own war time needs, not for selling PGM metals below cost to the world.

In Impala's estimates, recycling accounts for 1.1M ounces of palladium supply in 2008. CPM Group estimated the recycling as high as 1.6M ounces a year. The good news is this supply will also be removed in 2009. A new catalytic converter contains about 4 grams of palladium. An old one has about 2 grams left. Recycling recovers about 75%, or 1.5 grams each, worth about $9 in palladium at today's price. The PGM recycling is a long complicated and costly process. At today's low price there is simply no incentive for recycling. Stillwater Mining (SWC) is better off dropping the PGM recycling business now and concentrate on mining. This can boost the metal's market price as well as unlock large working capital that was locked up in the recycling materials inventory, and hence enhance the company's balance sheet.

On recycling, more than 1M ounces of palladium supply are removed. Mining production also dropped significantly. Norilsk Nickel estimated the 2009 palladium production to drop to 2.6M ounces from 3.0M as they now mine the nickel rich and palladium poor minerals to reduce cost, as well as process third party nickel concentrates which contain no palladium. North America Palladium (PAL) shut the mine down earlier, removing another 0.280M ounces supply. South Africa also saw about 10% drop of palladium production, or 0.25M ounces. Stillwater Mining (SWC) also expects reduced production in 2009.

When you add up all the supply disruptions and halt of Russian stockpile sale, despite of a 5.3% drop in auto catalyst demand, we are looking at an unprecedented palladium deficit in 2009, far bigger than in any other precious metals. And we haven't added in potential investor demands! Who wouldn't want to buy some palladium if you know what's going on!

The collapse of PGM prices in recent months was NOT due to fundamentals; rather it was due to investment funds as well as big auto makers were forced to liquidate their precious metals holdings to raise cash. Especially General Motors (GM). Auto makers normally keep 6 months of PGM metals supply to weather any supply shocks. When GM struggled for its survival, it had to sell its PGM inventory at cheap prices. Now that GM says it can expect to survive without more government money. It's time for GM to rebuild the inventory in light of the looming shortage.

Palladium has by far the strongest fundamentals and the best potential for an explosive rally, among all precious metals. I still believe that due to the huge above ground inventory of gold, and the current price above the intrinsic value of production cost, the yellow metal has little room to gain in real value. Gold is a liquid and stable currency, but has no investment value if you are looking for gains.

I like silver better than gold. Silver is mostly a by-product metal so the supply is price-inelastic. As a safe haven investment, silver is more appealing to Joe-Six-Packs as it is more affordable, while gold is more appealing to rich people due to its high density of value. Most people on the GoldIsMoney forum believe silver is more bullish.

But none of the silver bugs even presented specific and quantitative data on silver supply and demand so I want to have a closer look. Photography usage of silver, which traditionally accounts for 1/3 of the demand, is now diminished as digital cameras replace analog ones. Sterling silverwares like spoons and goblets are also going into history. Industrial demand saw some increase in recent year but is uncertain as the global economy goes into recession.

The biggest uncertainty factor is silver jewelry. Silver jewelries are low end cheap jewelries. They are those cheap bling-blings you pick up in a mall or a grocery store when you happen to have a few extra dollars and you just like what you see. So in a sense silver jewelries are discretional spending items and are vulnerable in a slowing economy.

The high end jewelries made of gold, especially platinum and palladium are different from silver. They are rarer, and are more likely purchased as some special gift rather than casual spending. No one would buy a silver earring or necklace as an engagement gift, for example. Your fiance(e) will expect a diamond ring made of platinum, palladium or white gold. People will not tender their platinum wedding bands to pawn shops for cash, but they are perfectly happy to toss out old silver jewelry pieces.

Unlike PGM recycling, which is complicated and costly, recycling from scrap silver jewelries is simple and inexpensive as the materials contain high concentration of silver. Silver recycling remained at near constant high level over the past years, regardless of silver price. The PGM metals are different as low PGM prices discourage recycling and reduce the supply.

I believe silver remains bullish due to investment demand. But due to uncertainties in industry demand, I recently reduced my silver mining stock holdings in SSRI, PAAS and HL, and concentrated more on palladium mining stocks, SWC and PAL. The continued strong rally in Baltic Dry Shipping Index (BDI) shows I made the right call on the shipping sector. So I continue to hold large positions in shipping stocks, like EXM, EGLE, GNK, OCNF and DRYS.

Full Disclosure: The Author is heavily invested in palladium mining stock SWC and shipping stocks EXM, EGLE, GNK, OCNF and DRYS. I also hold positions in PAL, USO and OMG.

46 comments:

JJ2000426 said...

Johnson Matthey has noticed the Mazda announcement and they did not read too much into the development. Here is what they had to say about Mazda's technology:

Thrifting of precious metals in autocatalysts

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