March 2019 Member Digest
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Proof That Commodities are Crucial – Platinum and Palladium

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Part 1 of the PDAC Conference Series for 2019

This year’s PDAC conference felt underwhelming. About half of the seats in most of the meeting rooms I was in were empty. This could be construed as a positive thing, because resource investment is very cyclical. In fact, when a sector of the market is not in vogue is usually the best time to consider putting money into it. In other words, buy low and sell high while avoiding the hysteria of bubble markets.

It’s All A Fugazi

Before I get into my conversations with company representatives, my usual disclaimer here will apply. Stock investing is much like gambling, so do it at your own risk. There are no guarantees regardless of what your broker, or favorite newsletter writer, insists are sure things. That is why I have never focused this site on stock picking, but rather on education and understanding long term fundamentals of the markets to protect your cash and put it in safe, long-term assets. The following video from Wolf of Wall Street aptly sums the scams that are perpetrated on unwary investors by the industry.

Here is a quote from the video which corroborates my short time as a licensed broker before I quit.

Mark Hanna: Think about Teresa. Name of the game, move the money from your clients’ pocket into your pocket.

Jordan Belfort: Right. But if you can make the clients’ money at the same time, it’s advantageous to everyone, correct?

Mark Hanna: No. Number one rule of Wall Street. Nobody, I don’t care if you’re Warren Buffet or if you’re Jimmy Buffet, nobody knows if a stock is gonna go up, down, sideways or in fucking circles, least of all stock brokers, right?

Jordan Belfort: Mm-hmm.

Mark Hanna: It’s all a fugazi. Do you know what fugazi is?

Jordan Belfort: Fugazi, it’s a fake…

Mark Hanna: Yeah, fugazi, fogazi. It’s a wazi, it’s a woozi. It’s…fairy dust. It doesn’t exist, it’s never landed, it is no matter, it’s not on the elemental chart. It’s not fucking real. Right?

Jordan Belfort: Right.

Mark Hanna: Alright?

Jordan Belfort: Right.

Mark Hanna: Stay with me. We don’t create shit; we don’t build anything.

Jordan Belfort: No.

Mark Hanna: So if you got a client who brought stock at eight, and it now sits at sixteen, and he’s all fucking happy, he wants to cash it and liquidate and take his fucking money and run home. You don’t let him do that.

Jordan Belfort: Okay.

Mark Hanna: Cause that would make it real.

Jordan Belfort: Right.

Mark Hanna: No, what do you do? You get another brilliant idea, a special idea. Another situation, another stock to reinvest his earnings and then some. And he will, every single time. Cause they’re fucking addicted. And then you just keep doing this, again, and again, and again. Meanwhile, he thinks he’s getting shit rich, which he is, on paper. But you and me, the brokers?

Jordan Belfort: Right.

Mark Hanna: We’re taking home cold hard cash via commission, motherfucker.

That’s the best lesson I can give you on the stock market. It’s a fugazi, and the brokers are taking home hard cash on commissions while you are happy with your paper profits. I never build a core investment position on stocks, or anyone’s debt like a bond. Because then you are basing your retirement on someone else’s ability to pay, and more importantly, the fact they are being completely honest to begin with.

That being said, let’s take at look at how the commodities markets are faring. I prefer to invest directly in the physical metals, where available, as a core position. This would include gold, silver, platinum, and palladium bullion, or in some cases even collectibles. I may speculate on the other commodities using purely discretionary dollars, understanding that I may never get them back.

The Palladium Market is Hot

In my recent article, I outline three reasons why the palladium market will get stronger. Even though the palladium spot metal price has doubled since August, this is not a typical market bubble. Because of emerging market demand surging for applications that use palladium, the metal will stay in high demand over time.

This is not to say that the palladium price cannot pull back along the way, even as much as several hundred dollars an ounce. But the fact remains that industrialization success of the emerging markets like China are going to ride on the back of critical materials, like palladium. Hence, why I am long term bullish on this metal.

North American Palladium

The only company that I could find at PDAC that primarily mined palladium was North American Palladium (PALDF). This company is one of the only “pure play” palladium producers in the world. This means that most of the dollars they spend on producing the metal are paid back from the palladium market price. They don’t have to use all sorts of byproduct credits to justify the success of their mine. Here is some information from their corporate presentation.

North American Palladium Capital Structure

North American Palladium Capital Structure

The company recently hired new management, and has turned around their operations. They have reduced costs while increasing production, always good news for investors. More importantly, it allows North America to have a palladium source not dominated by a major competitor in Russia or a political disaster such as South Africa.

NAP Operational Turnaround

NAP Operational Turnaround

Recent palladium price increases have made this company a darling. They have a strong profile of free cash flow with good margins. Their capital expenditures have been brought under control. After speaking with company representatives at the conference, I believe they still have good ground to go after for more resources.

NAP Free Cash Flow Chart

NAP Free Cash Flow Chart

From my perspective, this may be the only company on this continent that will help secure palladium for the North American industry that will depend on it. This makes North American Palladium a strategic resource critical to the success of the American economy. This is one reason that I expect palladium prices, in US dollars, to remain strong for quite some time.

And to reminder readers from my previous article citing why China will drive increased demand for platinum group metals (PGMs) such as palladium, here is a confirming chart from the company on market fundamentals.

Robust Palladium Market Fundamentals

Robust Palladium Market Fundamentals

A last slide I want to include from the company presentation regards inelastic supply, jurisdictional risks, and inventory depletion. This tells the story of palladium as a strategic, but very limited resource with declining supply characteristics. These factors will drive strong palladium prices into the future.

Palladium Market Long Term Catalysts

Palladium Market Long Term Catalysts

Palladium Versus Platinum

In my recent palladium article, I highlighted the differences in the platinum and palladium markets. Platinum has its own set of fundamentals that are similar, but with key differences. I said:

Platinum will make a comeback in the market, but not necessarily as a replacement for palladium. The demand for both metals will continue to rise as the emerging market demand for their uses grows. No longer is the US the primary driver for economic activity in the world. The rise of China’s middle class has changed the price base for nearly all commodities in the market, and will continue to do so in the long term.

Many investors are treating platinum and palladium as equal substitutes. Therefore, they will look at the price ratio between the two and balance investment dollars accordingly. I think this is a mistake for several reasons.

First, platinum and palladium have different use cases. Palladium is in fashion for gasoline engines that are perceived as more environment friendly than diesel. Palladium is more efficient in gas engine technology, and companies like Ford have stated it takes 18 months to re-engineer catalytic converters between the metals and bring them to market in actual vehicles.

Palladium also has a density advantage in jewelry; the fact that platinum is more dense means more grams are used in the same size jewelry pieces. Palladium is also harder than platinum; hence why it is often mixed with gold, a soft metal, to make white gold jewelry pieces. White gold has the luster characteristics of silver while being much harder than silver or gold. All while bearing the more illustrious title of ‘gold’ in the name.

Platinum Will Make a Comeback

Those points being made, I think platinum will make a comeback. There will be a breaking point in the palladium market where there just isn’t enough of it. The metal is rarer than platinum, so any growth beyond the stretching point of the palladium market’s breaking point will force manufacturers to begin substituting platinum.

South Africa’s political chaos injects so much uncertainty into market supply. When a country that supplies most of the world’s PGMs is this unstable, the industry should be preparing for inevitable supply shocks brought on by supply disruptions.

Palladium Supply and Demand

Palladium Supply and Demand

South Africa supplies 39% of the world’s palladium. Political problems will disrupt the market and cause price spikes and substitutions with platinum. What is worse; however, is that South Africa supplies an even higher percentage of platinum to the world market.

Platinum Supply and Demand

Platinum Supply and Demand

South Africa provides, less recycling, an astounding 73% of the world’s platinum supply! What is likely to occur is that both metal’s supply shocks will drive prices higher simultaneously at the apex of the political crisis. But it will affect Platinum even more than palladium.

Diesel Transportation Cyclic Changes

Longer term, I expect that Europe will reconsider the political decisions currently being made to limit diesel engines in commerce. The fact is that European travel, especially in trucking, is dependent on diesel technology. Advances in hybrid and electric cars cannot replace the demand for efficient, high horsepower output that diesel engines provide.

This is much like the world cannot do without nuclear power, and why uranium prices are finally starting to rebound as legislators around the world reconsider their antipathy towards nuclear reactors. Further, worldwide supply and demand characteristics for gasoline will prevent a complete redesign of the world trucking sector from diesel to gas engines. Trains and ships can only get supplies so far, trucks are needed for the last several hundred miles of the migration of goods to local outlets for trade.

Therefore, in several years after these laws are passed discouraging diesel use, citizens will demand they be changed to address rising prices of both vehicles and other goods transported to their locality. Politicians will compromise by passing laws to encourage ‘cleaner diesel’, while bringing it back in vogue. And the demand for denser platinum used in diesel catalytic converters will raise the price.

If buying low and selling high is your chosen investment philosophy, then buy physical platinum bars. Five to seven years from now, you will really be thanking me for the advice. Remember with patience come the best investment opportunities.

Platinum Versus Palladium Price Dynamics

The best time to invest in palladium was during the last financial crisis when we hit a cyclic low in world production. Whereas, platinum is trading now at almost exactly the same price as it was during the same period of time n 2008. Look at the two price charts (from APMEX) to see the difference.

Palladium Price Dynamics

Palladium Price Dynamics

Palladium, above, shows it may be near a peak before correcting. The correction, if it comes, likely occurs during the next financial crisis. I noted in the recent palladium article that this was likely to occur. However, given emerging market demand and the fact that the world economy has grown past it’s dependence on the US markets, I don’t think Palladium prices will completely crash. Instead, I think both the platinum and palladium prices will trough and then begin a new bull leg upwards. Who knows where they will land after the next recession, but it should be substantially higher.

Conversely, here is the platinum chart.

Platinum Price Dynamics

Platinum Price Dynamics

Notice how platinum shows a reverse triangle pattern from palladium. Platinum is indicating a cyclic  low in price, and likely accumulation is forming at these price levels that will push up the prices.

When the next economic recession occurs, the prices will fall perhaps down into the $500 an ounce range. But when they rebound, the next bull leg up could potentially be explosive in nature. Much more-so than palladium, platinum’s price has a long way to run. Remember, both metals will be crucial to the development of the emerging markets along with maintaining the status quo in the Western countries.

Next Economic Crisis: Will the PGM Prices Really Fall?

In my charting above, I am taking a traditional view of price dynamics during a typical recession. Prices tend to fall to previous lows, investors and industries eventually begin to accumulate, and prices recover in a newer high phase. However, as I outlined in my book, I think this next recession will be quite a bit different from the last several.

My charting above is technically correct, but the price corrections in PGMs, and other metals like copper, molybdenum, and rare earths, may not fall as much as forecasters may think. I think the next recession quickly morphs into a depression. Along with that sort of economic super cycle crash comes hot wars. And when the physical wars heat up, so does the arms industry.

Following are two charts from a government report on Strategic Materials in World War II. These charts are not meant to scare you. Rather, they are an historical account of what materials the US imports during times of war production, and how much increase in certain metals are used during a war. The report was authored by Dr. J.D. Morgan from the Bureau of Mines in 1983.

US Dependence on Metals in WWII

US Dependence on Metals in WWII

The first chart above shows how much dependence the US has on certain metals, such as platinum, molybdenum, vanadium, copper, silver, and gold. Note that palladium is not on the chart because the metals has a more recent history of industrial use, whereas platinum has a longer use in industry.

US War-Time Use of Prominent Commodities

US War-Time Use of Prominent Commodities

The chart above, from the same study, shows the peak increase in use of prominent industrial commodities during a war. All of the precious metals, including gold, silver, platinum, and palladium are used for purposes that will likely increase during war. The PGMs are used for vehicles, and gold and silver are used for computer circuits and other electronic demands.

Therefore, I think both palladium and platinum prices will skyrocket if the next crash produces a new war of any scale. Past economic collapses similar to the one I am expecting do precede war. If not world-wide, then certainly we will have war on a regional scale throughout the world. The next economic crash will probably rival the Great Depression, so I expect that all precious metals prices will rise in turn, sometime after the crash begins.

Next Up: Rare Earth’s, Copper, Gold, and Silver

This is part one of my report from the PDAC conference. I concentrated on the PGMs for this article. But the next one will focus on two distinct commodities: rare earths and copper. In addition, I will spend quite a bit of time talking about research provided by the best analysts at the conference. This research paints a very bullish picture for both gold and silver in the coming months and years.