2023-08-07 23:25:13 ET
Summary
- Palladium and the abrdn Physical Palladium Shares ETF are oversold, presenting a contrarian investment opportunity, as above-ground inventories remain low.
- Bearish market sentiment stems from a belief electric vehicle demand will erode palladium buying, while many automakers are already switching to cheaper platinum for catalytic converters.
- A record net short position in palladium futures could lead to a short squeeze and potentially sharp price increase.
- Any supply disruption from Russia or South Africa, on top of the potential for stronger ICE demand in an improving global economy, could support price.
Palladium and the abrdn Physical Palladium Shares ETF ( PALL ) are completely oversold, after declining hard over nearly two years by almost -65% from peak pricing. Sure, there are reasons to believe a serious rebound has scant chance of materializing. But, as a contrarian investor, buying when everyone else is selling can lead to “surprise” reversals and sharp gains in your portfolio. It’s been my experience, after a commodity has been sold down the river over a period of years, looking to fight the crowd can be a rewarding exercise.
Why am I considering opening a long position in palladium today? Let’s discuss the logic.
Reasoning for Bearish Market Sentiment
At estimated 85% of annual palladium demand comes from ICE auto production today, through uses to clean exhaust fumes in catalytic converters. The bearish logic goes electric vehicle demand is surging, which should crush palladium buying over time, as EVs do not emit byproduct gases like combustion engines. In addition, many auto makers are switching to platinum, substituting this cheaper metal holding many of the same chemical characteristics/uses as palladium.
After years of significant shortfalls in palladium mining to match growing ICE demand, 2023 has moved into a better supply/demand balance in the marketplace (about 17% of total annual supply is recycled material), mainly the result of falling industrial/auto demand. From the annual May 2023 Johnson Matthey report,
The palladium market is expected to move closer to balance in 2023. Supply should rise modestly, while we anticipate demand to be hit by further platinum-for-palladium substitution in gasoline vehicles. Automotive consumption is forecast to fall for a fourth consecutive year and will be around 15% lower than the 2019 demand peak.
So, with price falling from $3,400 an ounce in early 2022 (on Russia’s invasion of Ukraine and fears of supplies from this major producer) to $1,264 today, AND a bleak demand future becoming reality, who in their right mind would want to own palladium?
Commitments of Traders – Futures Market
That’s exactly the sentiment of trend-following short sellers in the futures market. The August 1st Commitments of Traders report highlights the RECORD net short position being built by retail speculators, both large and small (non-commercials on the chart below). This stacks up against a RECORD long position by palladium producers and end users (commercials). In terms of supply/demand balance in futures trading, the smart money is very willing to go long palladium in August, while hot-money traders believe shorting the metals is the “only” way to play things.
My view is a huge financial short position in paper futures could easily be talked into covering, creating a type of short squeeze that lifts both paper and physical palladium quotes. For investors understanding reversion-to-the-mean moves and counter-trend rallies can occur without much warning, we can basically identify a situation where any good news from demand or an unexpected shortfall in supply could cause a rush of extra buying interest from short sellers, on top of new buyers entering the marketplace.
Technical Trading Movements
Below is a chart of the wild price swings in nearby palladium futures over the last five years. Today, price is back to early 2019 levels, and roughly +35% above mid-2018 levels.
Over the past two years, price has slid greater than -50%, with market focus shifting from dwindling above-ground inventory toward the reality of rising EV sales vs. ICE vehicles. However, still ultra-low inventories are not going away quickly. The jury is out on how rapidly auto demand falls from 2023.
Another technical factor keeping pressure on palladium is the price ratio vs. platinum. Until the year 2000, palladium had historically traded at a price LOWER than platinum. The all-time ratio peak of 3x platinum was reached in early 2020. The current 1.36x remains statistically high. Yet, platinum is now entering a projected span of serious shortages, which may support a material price increase in that metal. Such could pull the relative pricing relationship back toward an equilibrium in 12-24 months without any palladium price drop.
Aberdeen Palladium ETF
The leading U.S. based ETF by size, holding 100% of its assets in physical bullion is the abrdn Palladium ETF - PALL. The fund charges 0.6% annually for management expense and was formed in 2009. Assets under management stand around US$230 million.
Below I have drawn a 2-year chart of daily price and volume changes. My favorite momentum indicators have not been as bearish as you would expect, given a multi-year decline in price. I made a small long trade in PALL during the March to April period based on resilient 20-day Chaikin Money Flow strength, and believe CMF positive action since July could be a signal to try a bullish position again.
New price lows since June have not been confirmed by trading direction in the Accumulation/Distribution Line or On Balance Volume . I know I am gambling a bit on suggesting a bottom, but I do not feel the charts will give us much clue of a retracement-like upturn higher.
In terms of how effective the abrdn ETF is at replicating palladium bullion movements, this investment security has lost 1.2% in value vs. spot quotes over 24 months, roughly nailing its expected 0.6% annual management fee decay over time.
Final Thoughts
Nearly 70% of 2023 palladium mine production is projected to originate in Russia and South Africa this year. Russia’s supply is facing western nation war-related sanctions, while South Africa miners have dealt with union strikes, electricity supply issues, plus temporary smelter and processing maintenance during 2023.
My primary guess for a catalyst news event, igniting a price reversal in palladium may come from an unexpected mine disruption in one of these less stable business jurisdictions. A potential secondary trigger might be a stronger-than-expected global economy into 2024, including oversized demand from gas/diesel engine manufacturers. My point is confident analyst/speculator projections for declining demand may be upset by supply shortfalls, meaning market sentiment could turn around 180 degrees and refocus on continued scant inventory levels.
Above-ground easy to find stocks remain quite low. For example, the NYMEX futures market is sitting on just 43,500 ounces of physical warehouse inventory backing up 1.87 million ounces of open interest (18,700 contracts x 100 ounces per contract), for 40:1 in paper trading leverage vs. callable metal. The TRIPLE in open interest over slightly more than a year is the largest percentage increase in “short” positioning in modern times.
The abrdn Palladium ETF is itself one of the biggest stores of physical metal, with roughly 180,000 ounces held. This compares to annual global demand estimates of a little under 10 million ounces for 2023. To be frank, estimates of 10-20 million ounces for above-ground inventory in 2014 have dropped to between several million to perhaps 5 million ounces of supply (on the high end), stored by miners, auto manufacturers, processors, end users, ETFs and trading exchanges. During 2014, PALL itself reported holding around 700,000 ounces , nearly 4x today’s assets. Years of substantial shortages in new mine supply vs. rising overall demand have eaten away at above-ground stock numbers.
My point is little wiggle room exists for price to decline further if a shortage situation reappears unexpectedly. My investment thesis is enough negativity for sentiment is in place for a bottom, while aggressive selling in the paper market has set up a mountain of potential buying (covering) fuel. Any swing toward normalization in trader/investor positioning could bring a +20% to +50% price jump rather quickly.
Of course, I am not betting the farm on a big palladium upmove, and this contrarian proposal may prove overly optimistic in the end. I suggest investing only a small portion of your portfolio into PALL. If price declines another 10% to new multi-year lows, cutting it loose and taking a loss may be the smart way to quickly reduce exposure and further downside risk.
Thanks for reading. Please consider this article a first step in your due diligence process. Consulting with a registered and experienced investment advisor is recommended before making any trade.
For further details see:
Palladium Overdue For A Large Rebound: Buy PALL