(The opinions expressed here are those of the author, a columnist for Reuters.)
* Palladium Lease Rates Go Wild: https://reut.rs/2VJ36LF
* How Emissions Rules Drive Palladium: https://reut.rs/3cyj7uJ
* Palladium vs Platinum Prices: https://reut.rs/2VkpKeq
By Andy Home
LONDON, April 20 (Reuters) - COVID-19 has roiled industrial metal markets with lockdowns around the world eviscerating demand, forcing mine closures and upending supply chains.
It's been a wild ride for the likes of copper, aluminium and zinc, all of which have plunged to multi-year lows.
So too for the precious metals complex with gold slumping in early March before rocketing to seven-year highs earlier this month as investors sought shelter from the macro storms.
Palladium, however, was a wild market before anyone had ever heard of the novel coronavirus. The spot price exploded from less than $800 per ounce in August 2018 to $2,875.50 in February this year.
Lease rates in the London inter-dealer market flexed to extreme levels in January-February, prompting Russian producer Nornickel to commit three tonnes from its "Global Palladium Fund" stocks to try and calm things down.
The metallic demand shock caused by collapsing automotive production and sales has been a core driver of the metals price volatility. In the case of palladium, though, it may just have the opposite effect.
But don't hold your breath.
ANIMAL SPIRITS EXTINGUISHED
Palladium has all the hallmarks of a speculative bubble, the unleashing of what John Maynard Keynes famously termed the market's animal spirits.
However, every indication is that the speculative beasts have largely fled a metal that is too hot to handle.
The fund long position on the NYMEX palladium contract peaked at close to 29,000 contracts in January 2018. As of last week it stood at just 1,835.
Palladium exchange-traded funds boomed in the early part of the last decade, reaching a cumulative holding of 3.03 million ounces in 2015. Holdings have since fallen by around 80% to 660,000 ounces, according to David Wilson, head of investment research at the World Platinum Investment Council (WPIC). ("Palladium: An introduction for Investors", March 2020)
It is quite possible that larger players built up speculative stocks away from the statistical glare of both the futures and the London dealer markets.
However, if they did so, those stocks are almost certainly lower than they were just a month ago.
Gold, silver, platinum and palladium prices all swooned in March in a collective slump widely attributed to banks liquidating physical holdings to meet margin calls in collapsing equities.
Palladium imploded from February's highs to a low of $1,482 per ounce before staging a ferocious recovery. It is today trading around $2,180.
The buyers behind the whiplash rebound were not other speculators but rather Chinese automotive companies desperate to acquire metal, according to the WPIC's Wilson.
Western car-companies have long-dated hedging programmes to reduce their materials price risk. Chinese companies don't, meaning the sort of sell-off seen last month was a golden opportunity to grab what they could at bargain-basement prices.
Indeed, Chinese automotive manufacturers' need to buy ever more palladium has been the main driver of this bull market.
Both platinum and palladium are used to make catalytic converters that reduce emissions of carbon and nitrous oxides in internal combustion vehicles.
Platinum has a range of other uses with automotive accounting for around 36% of global demand last year, according to the WPIC. However, palladium doesn't, meaning that autocatalysts account for more than 80% of usage.
The pressure to source more palladium is coming from the steady tightening of emissions regulations. China leads on this and is rolling out "China 6" standards, the tightest in the world. To meet them, car-makers need more platinum and palladium per vehicle. Particularly palladium.
Even though global light vehicle sales fell by 4% last year, palladium usage rose by 10%, or 895,000 ounces, as the Chinese market pre-emptively moved to "China 6" compliance, the WPIC notes.
This palladium bubble, in other words, is an industrial rather than a speculative one.
A PROBLEM WITH SUPPLY
Palladium supply has failed to keep up with this fast-rising demand and the market has been in deficit for much of the last decade.
Indeed, the price spike could have come sooner were it not for the release of speculative and industrial stocks, which have been eagerly gobbled up by Chinese auto-makers.
The problem is that no-one sets out to mine palladium. It is purely a by-product of nickel and platinum mines, most of which are concentrated in Russia, South Africa and to a lesser extent Canada's Sudbury basin and the Stillwater deposit in the U.S. state of Montana.
Palladium production is wholly dependent not on the price of palladium but that of platinum or nickel.
"For most commodities, such a strong and sustained price rally over a period of 10 years would incentivise investment, exploration and development of new mine capacity. Palladium's dominant by-product nature has prevented this," writes Wilson at the WPIC.
SQUARING THE SUPPLY-DEMAND CIRCLE
This is where palladium might actually reap some relief from the collapse in automotive production.
Analysts at UBS estimate that a 40% decline in Chinese auto sales and a 20% in global sales this year could push the palladium market into rare supply surplus, "all else being equal". ("Gauging the impact of auto sector risks on PGMs," April 15, 2020).
However, all else is far from equal.
The trigger for the late-March rebound in price was the lockdown of mines in South Africa, which generated a slew of force majeure notices from the country's major platinum and palladium operators.
The lockdown is due to run until the end of this month but one producer won't be returning to business as usual even if the restrictions are lifted.
Anglo American declared force majeure on March 6 after an explosion at its Waterval smelter in Rustenburg. Repairs will take around 80 days and the company cut palladium guidance for this year by 300,000 ounces to a range of 1,100,000-1,200,000 ounces.
That in itself could wipe out the potential palladium market surplus postulated by UBS on the back of a 20% contraction in global auto sales.
Whichever way you look at palladium, it's hard to square structurally limited supply growth with exponential demand growth coming from mandatory emissions requirements.
The only logical conclusion is that auto-makers will have to find ways of switching the amount of palladium they use in favour of platinum, which now trades at a steep discount to its geological sister.
The only question is how long this process takes.
Johnson Matthey, a major player in the platinum group metals space, warns that the "compressed phase-in schedule for China 6" regulations has left little time for substitution research.
"We do not currently expect any significant substitution of palladium in gasoline autocatalysts in 2020," it said in its February 2020 market report.
Which probably spells more wildness ahead for palladium, whatever the scale of the coronavirus impact on demand.
(Editing by Barbara Lewis)