Palladium price surges to 22-month high

Not an electric vehicle.

On Friday, the palladium price continued its strong run with Nymex contracts jumping 5% to $794 an ounce, bringing gains for the precious metal so far in January to 18% or more than some $120 an ounce. Sister metal platinum has also gained year-to-date, exchanging hands for $980 an ounce on Friday.

PGM price strength comes on the back of declining output from top producer South Africa, which together with Russia is responsible for more than 80% of global supply of the metals.

Top consumer China in December extended tax breaks on purchases of small vehicles

Data released this week showed South African output fell by 8.9% year on year and 3.4% month on month in November. In the January to November period, PGM production was down by 2.1% compared to 2015.

Despite a safety stoppage at the world’s number one PGM producer Amplats at the start of the year in general disruptions to supply were limited in 2016 a research note by Capital Economics points out.

In 2014 labour unions embarked on a gruelling five-month strike, but last year wage negotiations were concluded without disruptions:

What’s more, the average platinum price in South African rand terms rose 9% last year. This means that producers had no incentive to voluntarily cut output. This is also evident when looking at the revenue from PGM sales which were up 5% y/y in October and 3.5% in the first ten months of 2016.

Instead, we think that underinvestment over the past five years could be starting to negatively impact production. That said, any upside for PGM prices should be fairly limited as above-ground stocks remain abundant.

On the demand side the outlook for palladium and to a lesser extent platinum is also positive. Top consumer China in December extended tax breaks on purchases of small vehicles which were due to expire at the end of 2016 through this year. Roughly 75% of palladium demand is from the autocatalyst sector.

Palladium finds application in gasoline engines and is more exposed to the Chinese and US markets where diesel (platinum’s main industrial application) hardly features in the passenger vehicle segment.

Underinvestment over the past five years could be starting to negatively impact production in South Africa

While the Chinese tax will be lifted to 7.5% from the 5% (usual rate is 10%) where it has been since October 2015, the extension should keep vehicle-purchase prices in the world number one auto market chugging along.

The tax cut stimulated sales, as indicated by a 14% year-on-year increase in combined passenger and commercial vehicle sales during the first 11 months of 2016, according to the China Association of Automobile Manufacturers. The growth was driven by a 16% rise in passenger vehicles sales in the same period, which accounted for 87% of China’s combined passenger and commercial vehicle sales.

In a vote of confidence for the PGM market South Africa’s Sibanye Gold (JSE:SGL) (NYSE:SBGL) is buying Stillwater Mining (NYSE:SWC), the only US platinum and palladium producer, at a premium. The cash deal worth $2.2 billion cleared a major hurdle on Friday.

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