Parts of this post have been redacted due to the author’s wish to remain anonymous.
Palladium is not just the theatre in London or the bargain wedding band option anymore; we may see Atomic Number 46 glitter brighter than gold. Given QE2, QE3, QE Infinity, and the world’s fear of currency instability, perhaps this is the next big hedge fund trade. This is not so inconceivable; George Soros’ fund recently disclosed a 9.7 per cent stake in Platinum Group Metals Ltd. Is it likely that Palladium could be the next sweet metals trade?
A hedge fund bulk buying of Palladium may create cause obtuse pricing issues. Palladium is rarer than Gold or Platinum, with production at 6.3M ounces worldwide. Supply is relatively limited, originating from South Africa and the Russian Federation. There is potential for price manipulation if hedge funds buy in bulk, for two reasons:
- The Russian Federation, holder of the world’s largest stockpiles, has kept data very covert and may have large ability to influence prices.
- The ETF itself may be precarious. This year ETF Securities launched a Palladium ETF (ticker PALL). To quote from the prospectus: 
“As of April 22, 2010, the Trust held approximately 669,062 ounces of palladium that it acquired since it was formed on December 30, 2009, representing … approximately 8.0% of 2008 world palladium supply. Although the April 22, 2010 London PM Fix of $558.00 represents an increase from the London PM Fix of $422 when the Trust’s initial Share offering became effective on January 6, 2010, the Sponsor is unable to conclude that a long-term metal market price impact is being caused by the Trust’s holdings.”
Let us examine the reasons for and against a hedge fund buying spree.
Bull Case on Palladium
1. Long term growth story: catalytic converters in Emerging Markets
a. The auto industry may rebound as recovery takes hold and the world, especially China, demands Global Light Vehicles and low sulfur content fuels. Palladium is mostly used in auto-catalysts which enable compliance with clean air standards.
b. Substitution effect. Palladium can be a substitute for Platinum as it is cheaper and arguable more useful. Automakers have historically jockeyed between these two choices.
2. Monetary policy uncertainties, worries about the dollar decline, and inflation increase demand for bullion. The price has risen contemporaneously with these talks over the last three months.
Bear Case on Palladium
1. The long term demand story may not be as compelling as it may seem.
a. Cars, jewelry, and electronics rely heavily on discretionary spending.
b. Although Palladium may be cheaper than Platinum, the price tag may not be enough to tip the scales. The outlays necessary to redesign catalytic converters, for example, may not outweigh the benefits of the lower price.
c. The auto industry may be wary of relying on a metal whose supply is so heavily influenced by the political decisions of one major country.
2. Conflicting factors may create headwinds.
a. The price for Palladium is in Dollars, and purchasing power may have an impact.
b. There has been some supply emerging in the US and Canada.
There are arguments for and against the metal’s price momentum. However, with the fundamentals in such a delicate balance, excessive trading of the ETF by institutional investors such as hedge funds could cause perverse pricing outcomes.
Disclosure: Sara Grillo, CFA, holds shares of ETFS Physical Palladium Shares (NYSE: PALL), Platinum Group Metals Limited (AMEX: PLG), and North American Palladium Ltd. (AMEX: PAL). Diamond Oak Capital Advisors, LLC, may take or recommend positions in these securities on behalf of clients from time to time.
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