Scarcity and rising demand a plus for platinum

Most people in the car industry believe that rising gas prices will crimp car sales. However, according to a recent survey, 32% of Americans say they will buy a new more fuel efficient car if the price of gasoline rises above $5 per gallon. Thus, contrary to popular perception, increasing oil prices could spur the sale of new vehicles. In other words, the more it costs people to run their gas guzzling SUVs and pickup trucks, the more incentive exists.

Some market participants think they can capitalize on this phenomenon, which to a greater or lesser extent, is happening all over the world. They are sure that people want more comfortable trucks, buses and light-duty vehicles than gasoline engine technologies can provide. Many of the most astute people in the auto industry believe that this can all be accomplished by offering people inherently more fuel efficient diesel engine technologies. One of the believers is the very successful Bosch Corporation (BSE: BOSCHL.BO).

Bosch is German corporation that also happens to be one of the most prestigious and largest auto parts manufacturers in the world. In 2010, for example, it sold $63 billion worth of its products, worldwide. On May 15, 2011, the President of its North American division announced that the company would be investing in new factory capacity, to get ready for a major shift from gasoline-fuelled to diesel-powered engines in both small cars and trucks manufactured in the USA and Canada.

According to the company, rising oil prices will spur the sale of diesel up from a current three percent to at least 10 percent or more of all passenger cars sold in 2015. According to Bosch, the availability of the new low-sulfur diesel fuel in America opens the market to clean burning diesel and that small diesel vehicles could easily achieve an average of 54 miles per gallon. That is substantially better than either conventional powered and hybrid powered small vehicles can attain.

What is happening in North America is also happening overseas. Other Bosch manufacturing divisions, outside North America, have made similar commitments to diesel manufacturing operations. The company is putting money where its mouth is. It has invested billions of dollars in advanced diesel engine part manufacturing in China. It will invest yet $520 millionmore, this year, in various production facilities there, including “clean diesel” technologies.

The emphasis that Bosch is placing upon diesel is not new. The European company is the main diesel parts supplier in Europe, where diesel has dominated the market for years. Beginning in 1998, some of China’s major cities drew up local regulations to restrict diesel vehicles entering the cities. This resulted in a lot of fuel substitution by compressed natural gas and liquefied petroleum gas. Bosch confidently predicted in 2005 that clean burning diesel engines would penetrate to a minimum of 15% of the overall Chinese vehicle market by 2015. There are still 4 years to go, but diesel has already achieved dominance again.

Major local Chinese diesel engine manufacturer “China Lutong Parts”reports that total Chinese production of diesel vehicles rose to 1.078 million last year for an increase of 28.21 percent. The China Association of Automobile Manufacturers reported that sales of diesel buses increased to 280,400 units, with year-on-year growth of 32.90%. In comparison, the sales volume of gasoline buses rose to 120,100 units, a year-on-year growth of 17.53%. Lufong says that EU emissions standards are being implemented with respect to the new diesel vehicles.

EU emission standards mean a huge increase in the use of platinum. In spite of an intensive effort, worldwide, over many years, in which the car industry has sought to substitute platinum with cheaper palladium, the highest possible palladium loading in a diesel powered catalytic converter is 20-25%. This is only possible, moreover, with use of ultra-low sulfur diesel fuels, which will be, but are not yet widely available in China.

To get a better idea of what all this means to platinum prices, we need to examine exactly how much platinum is used in diesel and gasoline powered catalytic conversion versus how much platinum is being mined and how fast mining production can be increased, and at what cost? We can start by looking at new car sales. U.S. new car sales in 2010 were still depressed from normal levels at 11,588,783 units. Canadian new car sales for 2010 clocked in at 1.557 million units. Together, that totals 13,145,783 passenger cars and trucks. The combined total of the two nations, large though it may be, is considerably reduced from the combined North American total of about 18 million back in the glory days of 2006. The numbers now trail China, which sold about 16 million new cars in 2010.

About 8 grams of platinum, on average, are used in a diesel fueled passenger car. Much heavier loadings are used in heavy diesel fueled vehicles, like the buses and trucks they are building so many of in China. This compares with about 1 gram of platinum on average for cars with gasoline engines. Generally speaking, in all vehicle pollution control systems, all things being equal, the use of platinum is preferred. However, palladium is still much cheaper.

Scientists have learned to substitute most of the platinum in gasoline combustion systems with palladium. Yet, after years and hundreds of millions of dollars of investment in research, they can only substitute for about 20-25% of the platinum in diesel combustion systems, and that is possible only if ultra-low sulfur fuel is used. Moreover, if the price of palladium continues to rise, many manufacturers may switch back to platinum even for gasoline vehicles.

The role of platinum in the jewelry market is also very important to prices. Jewelry demand interacts with industrial demand much like Indian gold jewelry demand bolsters investment demand in gold. Indeed, a prerequisite for “monetary metal” status is that a precious metal must have substantial jewelry demand. Monetary metals must be valued for themselves, rather than simply for what they can do as a part of other products. Right now, about 2.42 million troy ounces of platinum is used to supply demand from jewelers, or about 40% of total yearly production. In comparison, about 22% of all silver demand comes from jewelry and silverware demand combined, with another 26% or so arising out of coin, medal and implied investment demand.

The price of gold and platinum interact, with platinum being the more prestigious and “desirable” metal, given its history of being more expensive than gold. A jeweler in Oklahoma, for example, has been quoted as saying, back in 2010, that:

Gold is selling platinum now. The price of gold is selling platinum. Platinum sales have surged in our store.

As the price of gold rises, and the price differential between platinum and gold narrows, people buy more platinum. For example, with platinum averaging $1609 and gold priced at about $1,225 per troy ounce in 2010,platinum jewelry demand has picked up by 30% in America, and there is every reason to believe they will rise further in 2011. In China, jewelry buyers forced to compete with auto makers felt “sticker shock” and jewelry sales were down 21%. The Chinese seem to have been patiently waiting for lower prices that never materialized.

By the end of the first quarter 2011, Chinese jewelers seem to have become desperate. According to Lonmin PLC’s quarterly report for the period ending on March 31, 2011, Chinese jewelers consumed almost 80% more platinum in Q1 2011 than they did the year before, even though platinum jewelry sale numbers had not fallen yet, in early 2010. This buying spree was stimulated, apparently, by a price reduction of a mere 8% resulting from the Japanese earthquake that disabled a number of auto factories. In India, where buyers managed to get accustomed to soaring gold prices in 2010, platinum jewelry sales were also up by 45-50%, even at high prices. Now that the price resistance has broken down in China and India, we should expect platinum jewelry sales to continue to rise in 2011, as the price of gold rises.

Let’s give an example of how the price of gold and platinum jewelry interacts. Suppose the price of gold rises to $2,000 per ounce. Let’s say that this price rise reflects investor interest, arising out of bad economic times, and that the recession reduces gold jewelry demand by 25%. Meanwhile, let’s assume that the price of platinum has risen to $2,100 per ounce, $100 higher than gold.

Total jewelry-based demand for gold in 2010 was 2059 metric tons. If that went down by 25%, it would leave the remaining demand at 1544 tons. But, let’s say that people begin to notice that platinum, which was once several times more expensive than gold, is now selling for only $100 more per ounce. If just 5% of that remaining gold jewelry demand shifted to platinum, additional demand in the amount of 77 tons of platinum would automatically be created. World platinum mine production each year is only about 6.1 million troy ounces, or 180 tons. So, 77 tons of new demand would support platinum prices against even a complete breakdown of the auto industry.

In fact, back in the Fall of 2008, when platinum prices temporarily collapsed, that is exactly what happened. Asian jewelry demand increased several-fold in response to the equalization of gold and platinum prices in jewelry stores. But, something big has changed since then. There has been unprecedented dollar, pound and Euro funny-money printing, and a general debasement of most fiat currencies worldwide. Quantitative easing showed the world that casino bankers, and their minions at western central banks, had both the power and the willingness to sacrifice savers and taxpayers in order to conjure up paper money from thin air for the use of their friends. They engaged in actions once thought unthinkable, permanently destroying the illusion that fiat currency can serve as a “store of value.” The value of precious metals in remedying such abuse is unlikely to be forgotten any time soon, for the worst of the coming monetary nightmare has yet to be seen.

The price of gold, in turn, is the rock bottom to which platinum can fall because of the relationship between the two metals that has been discussed, above. CPM Group noted the strong 83% correlation between gold and platinum prices as far back as 1995. In fact, from 2002 to August 2008, the correlation increased to 95%. By 2008, with the collapse of Lehman Brothers, the long term relationship fractured temporarily, mainly because a platinum long position-holders in the futures markets found their resources frozen and, secondarily, because of a nearly complete breakdown in the sale and financing of automobiles. That is unlikely to repeat itself. Even in the wake of Lehman Brothers, however, platinum prices fell only a few dollars below gold prices, and that, for only a few days.

Being backstopped by gold on the downside is nice because, as a result of monetary factors and societal instability, gold is almost certain to head higher in the coming years. However, equally important is that platinum has an open sky for positive price appreciation. With some exceptions, industrial raw materials cannot rise dramatically over a long period of time if the price amounts to a large percentage of the total cost of a product. In such a case, the increased price of the material translates into a significant increase in the final cost of the product. This creates a negative feedback loop in the form of decreased sales and downward price pressure.

Only about 8 grams (0.257205 troy oz) of platinum are needed in an average passenger car diesel engine catalytic converter. That is about $458 worth of platinum at the current $1780 price. Even if platinum prices rise to $4,000 per ounce, tomorrow, the platinum cost would rise to only $1029, or about $571. A gasoline powered vehicle’s platinum load would only become about $71 more expensive. According to the Detroit Free Press, the average price of a new car in the United States in 2010, was $29,217.

Diesel fueled cars are the primary users of platinum, whether in the USA or elsewhere. Wealthier inhabitants of the emerging market nations are smart enough to realize, like their European and American counterparts, that diesel cars sell for a few thousand dollars. They are also likely to recognize that this cost is more than offset by engines that tend to last 2-3 times longer, while getting about 30% more energy from a given amount of crude oil.

A $571 increase in the price of platinum can be easily absorbed with virtually no effect on sales volume. That would be the full effect if the price of platinum more than doubled from where it is now. The result would be a net reduction in the cost of car ownership if the source of the price increase were a large increase in the sale of diesel fueled vehicles.

A position in platinum can be taken using a number of different financial products. You can buy small bars or coins at most coin shops, or secure larger wholesale sized bars from Fidelity Investments, which can send it to your home by FedEx if you ask them. Another option is to buy the ETFS Platinum Trust (PPLT), but a negative is that, like other such arrangements, including GLD and SLV, you pay a hefty 0.5% administrative fee every year. Another possibility is to invest in futures positions long at NYMEX. Going the NYMEX route, however, means dealing with what appears to be periodic attempts to “harvest” performance bonds by abruptly changing requirements, selling enormous quantities of short positions, and thereby kicking people out of their positions using margin calls, and stop loss order cascade triggering techniques. If you do buy at the futures markets, you can roll over your investment each 3 months, but that involves paying a very heavy administrative fee for paper platinum that may never exist. Or, you can take delivery, as JP Morgan Chase bank has chosen to do on its own behalf or that of its clients.

You can invest in the stock of a number of different companies that mine platinum, including Stillwater Mining (SWC) as well as the ordinary shares (or ADRs if you are American) of Lonmin (LNMIY.PK), Anglo-American (AAUKY.PK), North American Palladium (PAL) and others. Stock investments, however, always put you at risk for bad management decisions, as well as the tendency of modern bureaucratic managers to vastly overcompensate themselves. Also, with respect to PAL and SWC, the majority of production is palladium. Palladium is a PGM series metal that shares many characteristics of platinum, but it is not platinum. There are many distinct differences that make it a different type of investment.

The short term price of platinum, like gold, silver and palladium will continue to be determined by capricious decision-making of various large hedge funds and large bullion banks that control futures markets. That insures a roller coaster ride, much like the one that has characterized gold and silver since they started being traded on futures exchanges in 1974. But, with a strong stomach and a firm knowledge of the fundamentals, one can safely ignore the gamesmanship and concentrate on the longer term view. The long term view is one of increased scarcity and demand, with an inevitable large increase in real value and price, compared with other assets.

Disclosure: Long precious metals.