South African index trackers may rue getting sucked into palladium boom

Fears that factors such as the US-China trade dispute and Brexit will reduce auto demand have the merit of focusing attention on palladium end-use. As I argued on 22 March, the long-term case for palladium is far from unambiguous. Ever-increasing regulatory demands are likely to prompt carmakers to move directly to electric vehicles, rather than using palladium for catalytic converters to reduce CO2 emissions.

Surging palladium prices contributed to a 7% advance for the South African stock market in the first quarter, with Implats and Amplats leading the way. Fundamentally, there’s little in the wider picture to justify the Johannesburg stock market’s performance.

• The African Development Bank (AfDB)’s African Economic Outlook 2019, published in April, points out that economic growth in South Africa has been on a virtually uninterrupted downward trend since 2011. According to the AfDB, the Southern Africa economy as a whole is projected to grow more slowly than other African regions in 2019 and 2020, held back by South Africa’s poor performance.

Palladium close to balance

Implats, the world’s second-largest platinum miner, plans to start building a new palladium mine at Waterberg that could start producing in 2024. CEO Nico Muller argues that the shift in palladium demand is structural rather than cyclical. The company is also considering increasing production at its Mimosa mine in Zimbabwe.

Amplats, meanwhile, raised its full-year dividend, confidently predicting that automotive demand for palladium will continue to grow. Yet risks remain.

According to a report from Johnson Matthey in February, the palladium market was in fact close to balance in 2018, with both North America and China seeing modest declines in passenger car output.

• Recoveries of palladium from automotive scrap continued to climb at double-digit rates.
• Primary and secondary supplies combined increased by 9%, with gross demand rising only marginally. Price action, however, suggested a market in structural deficit.
• Johnson Matthey expects that the palladium market deficit will widen in 2019. However, the report points to the unknown quantities of palladium produced during the Soviet years and now held by the Russian Central Bank. There is no way of knowing when this will hit the market.

Aluminium acquires allure

Unloved and relatively forgotten, aluminium may offer a less volatile play on the global theme of cleaner transport. As Candriam Investors argued in a 2018 report on green metals, aluminium can be infinitely recycled, with production from recycled aluminium on average requiring 95% less energy than for initial production. Solutions to reduce vehicle weight will be crucial for carmakers in the long term, and aluminium’s lightness is an outstanding benefit that won’t be displaced by electric vehicles. Battery weight is a key obstacle in the transition to electric vehicles: an electric car battery can weigh 500kg. The report highlights that electric vehicles are the only available solution for zero-emission transport.

Bottom line

The palladium boom has been driven by the assumption of future demand from a global auto industry that is in a period of rapid technological flux. Investors who are exposed to South African palladium mining should look more closely at which metals the car industry will ultimately need to reduce emissions.