Now that the South African miner's strike appears to be coming to an end investors may be looking to cash out on their palladium-related stocks after a labor dispute contributed to the metal rallying about 20% since the start of the year. However, a quick examination of the fundamentals of the palladium market suggests that this may not be the best decision; in fact now may even be a good time to look at adding palladium investments to your portfolio.
Even without strike, supply chain is tight
While the deal reached between the union representing the workers and the major South African miners mitigates the immediate supply threat that contributed to palladium's quick ascent, overall the supply situation is in no way completely stabilized. Palladium was forecast to be in short supply even before the labor dispute. The disruption simply exacerbated the situation.
The problem with palladium's supply chain is that more than 80% of the world's palladium is produced by two countries: South Africa and Russia. Recently, both these countries have been dealing with problems that have affected supplies.
The latest labor dispute in South Africa is only unique due to its duration, lasting almost six months. Supply chain disruptions in the country are frequent. It seems we can't go more than a year without a strike, and when strikes are not crimping output, power supply issues rear their ugly head.
Historically, Russia could come to the rescue when the palladium market was in a shortage, but over the past decade Russia has not stepped up to the plate as much as it used to. According to palladium analysts this is because the country simply no longer has the palladium reserves to intervene. But, because Russia does not release stockpile data, it is anyone's guess why the country has stopped adding surplus palladium to the global market.
Adding more pressure on Russian supplies was the recent geopolitical tensions between the country and Ukraine. Western powers enacted, and have threatened more sanctions against Russia due to its actions in Ukraine. These sanctions had, and have, the potential to impact palladium exports.
Demand for palladium remains robust
Palladium's primary use is in the auto industry, as an auto catalyst. As the global economy has improved over the past couple of years, so have the demand expectations for the commodity.
A great deal of increased demand for palladium will come from emerging markets, which are currently undergoing a rapid increase in wealth. This increase in wealth means higher demand for more luxury items including cars and jewelry.
In addition, palladium is starting to see an influx in investment demand. Historically, palladium has not been as popular of an investment as its precious metal counterparts gold and palladium, but the metal's recent rally is attracting the attention of investors, and this is turn has resulted in more interest in physical-backed ETFs – which in turn has created more demand for the metal.
A deepening deficit
The latest forecast released by Walter de Wet of Standard Bank points to a 2014 palladium market deficit of 2 million ounces. Back in April, when the South African miners' strike was in its fourth month, de Wet forecast a 1.5 million ounce deficit. Looking forward, for 2015 de Wet predicts a 1.3 million ounce deficit, and in 2016 he estimates the deficit will be 1.8 million ounces.
The best opportunities in palladium are outside of top producers South Africa and Russia. Unfortunately, there are few options.
Stillwater Mining (NYSE:SWC) has an operational PGM mine in Montana, and is currently developing new PGM mines. The company posted strong results in 2013. Revenue increased 30% year over year. Its first quarter was mixed. The company reported EPS of $0.15, more than double the Capital IQ consensus estimate of $0.07, but according to two analysts revenue was a shortfall. Still, overall the company's financials are robust, with cash and liquid investments on hand. The company also continues to make money-conserving decisions even though its current financial state is strong, which shows good management and positions the company for more future success. When asked about the recent rally in palladium and platinum prices, the CEO said he would not immediately step up production just to cash in, a move many miners often do and then are put in in a bad place when prices level off. In addition, Stillwater has recently offered some union members buyouts to conserve money, and signed a supply agreement with Johnson Matthey.
The only other North American option is North American Palladium (NASDAQOTH:PALDF). North American Palladium's financial position is not as stable as Stillwater's. The company has struggled to maintain profitable operations for some time, and posted a per share loss in the most recent quarter. While a struggling company can make a great turnaround story, the company continues to acquire a great deal of debt to increase production, and given its struggles to consistently turn a profit, acquiring more debt puts investors in a risky position, for now.
The medium- and long-term case for palladium in strong, but unfortunately there are only a few options for investors outside of South Africa and Russia. The limited supply may provide even more support for the value of these investments, with Stillwater mining being the "safest bet", but North American Palladium should be watched to see if it could make a great turnaround story.