2023-07-09 08:42:03 ET
Summary
- I advise against investing in Palladium and the abrdn Physical Palladium Shares ETF due to the rapid adoption of electric vehicles, which do not require catalytic converters - a major use for Palladium.
- Despite historically outperforming gold, I predict a decline in demand for Palladium as the sale of internal combustion engine vehicles decreases, putting pressure on Palladium prices.
- I suggest investors looking to invest in precious metals as a store of value should stick to gold bullion, which does not face the same demand issues as Palladium and Platinum.
To be honest, I am a bit of a gold bug, a habit I acquired from a former employer. For thousands of years, gold and other precious metals have acted as a store of value for human civilization, and they will likely act as a store of value for many years to come. That is why I always hold a bit of gold and other precious metals in my personal portfolio, typically 5-10%, depending on their relative attractiveness at the time.
However, when it comes to precious metals, I am least bullish on the prospects for palladium, and by extension, the abrdn Physical Palladium Shares ETF ( PALL ). This article will explain why.
Fund Overview
The abrdn Physical Palladium Shares ETF reflects the performance of the price of palladium, less operating expenses. The PALL ETF's operations is very simple; it issues units and uses the capital raised to acquire physical palladium bars held in custody in secured vaults in London and Zurich. The vaults are inspected twice a year and a list of physical bars is posted on the fund's website .
The PALL ETF has $230 million in assets and charges a 0.60% expense ratio.
Returns
The PALL ETF's historical returns track the returns of spot palladium prices, less management fees. Over the long run, the PALL ETF has provided modest returns with 3/5/10Yr average annual returns of -13.5%/5.0%/6.3% respectively to June 30, 2022 (Figure 1). In general, this has been better than long-term inflation, so palladium has protected investors' purchasing power.
Investors should note that palladium is a more volatile precious metal than gold, but historically, it has outperformed gold as modeled by the SPDR Gold Shares ETF ( GLD ). PALL has 10Yr average annual returns of 6.3% compared to only 4.4% for GLD (Figure 2).
Palladium Rode The Catalytic Converter Wave
Palladium is a soft silver-white metal in the platinum group metals ("PGM") family that was discovered in 1803. Palladium and platinum are well known for their resistance to oxidation and corrosion and has excellent catalytic (ability to surface oxygen as a reactant) properties.
The most common industrial use for Palladium is in automotive applications within catalytic converters that reduce emissions. According to Sprott Asset Management's research , 80-85% of Palladium's end use is in automotive applications (Figure 3).
Historically, platinum has the longest track record of the PGM metals of being used as autocatalysts, with a history of use in both diesel and gasoline vehicles. However, metals within the PGM family can be substituted for each other, especially between palladium and platinum in a historic 2:1 ratio.
There is debate between which PGM is best suited for diesel and gasoline vehicles. Generally, platinum is preferred in diesel catalytic converters and palladium is preferred in gasoline ones, as the high sulfur content of diesel fuel made palladium less suitable . Overall, demand for the PGM metals have soared since the 1990s as emission standards tightened globally (Figure 4).
Due to their substitution effects, the two precious metals historically traded roughly in a 2:1 price ratio. However, since the late 2010s, palladium prices have actually overtaken the price of platinum (Figure 5).
There are a number of reasons for this pricing dynamic. First, palladium is about 15 times rarer in nature than platinum, so it makes intuitive sense for palladium to trade at a higher price. Furthermore, technological breakthroughs in the 2010s reduced the catalytic substitution ratio to 1:1, narrowing the former 2:1 price gap. Finally, palladium is primarily produced as a byproduct from mining other metals, so its supply is quite inelastic. In fact, despite surging prices, global mine supply of palladium have not increased much in the past decade (Figure 5). When demand for palladium increased due to tightening emission standards, price inevitably follows suit.
Electric Vehicles Do Not Need Catalytic Converters
Unfortunately, the role of palladium as an autocatalyst within gasoline engines is ultimately leading to its downfall. Globally, the sale of electric vehicles ("EV") that do not have catalytic converters have been growing at a rapid pace, reaching an estimated 26 million vehicles by the end of 2022 (Figure 7).
In 2022 alone, the electric vehicle fleet grew by 10 million vehicles and EV sales are estimated to reach 14 million in 2023. Although still a relatively small percentage of annual global vehicle sales of ~70 million, EV's rapid adoption rate is nonetheless impressive and worrisome for palladium and PGM investors (Figure 8).
Every electric vehicle sold directly reduces the demand for palladium that are used within catalytic converters in internal combustion engine ("ICE") vehicles.
Since a large part of palladium supply already come from recycling old catalytic converters (from Figure 5 above), over time, the industry may even phase out the need for new mine supply, as recycling may be sufficient to satisfy industrial, jewelry and investment demand.
However, the same inelastic supply (byproduct of mining other metals) effect that caused palladium prices to rally to over $3,400 / oz may reverse and cause palladium prices to crash as physical palladium will continue to be produced despite reduced demand and weigh on palladium prices.
Therefore, for investors looking to invest in precious metals as a store of value for the long-term, I suggest they stick to gold and silver bullion, as gold and silver does not have the dramatic negative demand headwinds from EV/ICE switching that palladium faces.
Upside Risks To Palladium
Above, I have outlined a long-term bearish outlook for the price of palladium. However, palladium is also a small market that can be periodically squeezed by macro events. For example, in 2022, when Russia invaded Ukraine, palladium prices briefly soared to over $3,400 / oz, as Russia holds roughly half of the world's reserves of palladium (Figure 9).
However, as supply chains normalized, palladium prices have fallen to recent levels of ~$1,250.
Another factor to consider is that speculators can push around the price of a small market like palladium. In fact, large speculators have gone from historically being net long palladium futures to holding a large short position recently (Figure 10).
While this is negative currently, speculators can also be 'squeezed' if supply disruptions like 2022's Russia/Ukraine war were to reoccur.
Conclusion
The abrdn Physical Palladium Shares ETF ((PALL)) provides exposure to the price of palladium. Due to the rapid adoption of EVs, palladium's long-term investment outlook is negative. For investors looking at precious metals as a store of value, I suggest they avoid palladium and platinum.
For further details see:
PALL: Palladium May Be In Terminal Decline