LONDON () -- Today heralded the start of platinum week when the great and the good in the industry gather in London for a series of events, meetings and deliberations on the past, present and future of the business. As always, the week's events began with the launch of Johnson Matthey's [LSE:JMAT] annual review of supply and demand trends: the Platinum 2008 report.
It has certainly been an eventful year in the Platinum Group Metals (PGMs) market. Since the publication of the review , the platinum price has soared 65% to today's level of $2155/oz, palladium is up 24% at $454/oz while rhodium has risen 52% to $9,500/oz, (and is thus 18 times higher than the $530 average price of 5 years ago).
Most of the rise has occurred since the beginning of 2008, and according to Johnson Matthey the two key underlying factors have been the power cuts in South Africa, (which have hit the platinum sector particularly hard as the country accounts for 77% of world production), and the surge in investment demand.
Looking ahead, Johnson Matthey forsees considerable volatility in PGM prices with the six-month price outlook ranging from $1,775-$2,500/oz for platinum and $400-$575 for palladium.
While there are some relatively "known knowns," such as the outlook for the autocatalyst market (which accounts for over half of PGM demand), there are also some very significant "known unknowns," such as investment sentiment, jewellery demand, the dollar (which is closely correlated with platinum prices) and the level of recycling and supply disruptions. It is these unknowns, together with some of the unique features of the PGM market, which will determine future price trends, according to both the Johnson Matthey report and a Resource Investor interview last week with Mark Bedford, JM's Director of Precious Metals Marketing, and Dr. David Jollie, JM's Publications Manager.
Here are some of the key points, looking firstly at platinum.
Platinum
1. The supply/demand balance will continue to set the tone for the price, though to a lesser extent than in the past.
As JM's chart shows, there has been a clear correlation for the last thirty years between the size of the supply/demand surplus or deficit (shown in red) and the price trend (in green). While the external environment is becoming increasingly important, and the supply/demand balance less dominating than a few years ago, the balance will nonetheless act either to support or dull investor sentiment.
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2. In 2007, the platinum market was in deficit by 480,000 ounces, equivalent to 7% of global production.
Supply fell 4% on the back of strikes, labour shortages safety issues in South Africa while demand rose 9% driven by increased purchases for autocatalysts and industrial uses.
3. The platinum price is now in uncharted territory, so there is no historical precedent to use for considering the sensitivity or elasticity of the demand response to current price levels.
The previous peak in platinum prices was at lower levels, (at $1,040/oz in March 1980), and the platinum world was then a different place from today with a very different structure of demand. There is thus no real precedent for estimating the response of the various components of supply and demand to the current high level of prices, though these responses will be undoubtedly be a key factor in determining the price evolution.
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4. Nonetheless, some components of the supply/demand balance are significantly less price sensitive and hence easier to forecast than others. It is clear that the bottom won't fall out of the market.
Platinum differs from gold in that around 75% of demand is now for essential uses: in autocatalysts and other industrial applications including chemical industry catalysts, petroleum refining, glass manufacture and electronics (especially in the manufacture of hard disks). Many of these require platinum for its unique physical properties, and as platinum is only a part, albeit a growing one, of the total cost price, they are relatively price insensitive.
Platinum demand for use in autocatalysts is likely to remain strong in 2008 boosted by ever increasing legislative requirements to reduce emissions and by growing auto production worldwide. It will be offset in part however by thrifting and substitution as high prices drive engineers to produce ever more ingenious solutions to use less of the metal.
Platinum's other industrial uses are skewed towards sectors such as hard disks which are likely to remain reasonably buoyant despite the economic slowdown. Although at current prices there is clearly an inventive to substitute JM has not seen much evidence of this to date and it does not anticipate wholesale changes in the industrial market in the short to medium term.
5. Jewellery demand and the level of jewellery recycling will be two of the "known unknowns."
Platinum jewellery demand was fairly resilient last year, falling just 3% globally despite higher prices. Some sectors within the market are likely to remain reasonably insulated this year, particularly the bridal market and high end platinum jewellery.
However the impact of the very high prices on other jewellery sectors is hard to gauge and there is likely to be increased recycling of jewellery particularly in Japan, which is the most mature of the platinum jewellery markets. Platinum jewellery is expensive to stock, (and at current lease rates it is also expensive to borrow), so there is an incentive for retailers to keep stocks lean. The reduced offer may have some impact on consumer demand.
6. Investment demand will be a key determinant of price even though it is relatively small in comparison to other investment vehicles.
The platinum market is very small relative to other markets; for example world demand last year was around $9 billion compared with gold demand of approximately $79 billion. The net investment market has been particularly small representing 2.4% of the total platinum market in 2007 compared with 18% for gold.
However the market is growing strongly. Two ETFs were introduced in April 2007 and while they had limited impact initially, with just 65,000 ounces acquired in the first six months, the market has since accelerated rapidly with 130,000 ounces purchased in November/December 2007 and 200,000 ounces to date this year.
This is a very difficult area to forecast in the light of the U.S. sub-prime crisis, the uncertain economic climate, stock market volatility, the changing relative attractiveness of other investments, and the lack of a historic data series on ETFs on which to base a forecast. Johnson Matthey notes however that activity to date suggests that much of the money is invested over relatively short timescales and that demand and price are positively correlated i.e. when the price rises more metal is bought by investors. Nonetheless JM expect that ETF investment will not continue at the current rate.
7. The other major unknown will be the level of supply disruptions.
Supply disruptions to date this year have been caused by the power crisis in South Africa, flooding and personnel issues. While the power situation has improved recently it is not clear whether the onset of winter in South Africa will cause the crisis to resurface. There is uncertainty too about the impact of the political situation in Zimbabwe.
Johnson Matthey's bottom line is that supply is likely to be essentially flat in 2008 - maybe up just a notch on 2007 - while demand will continue to rise as gains in the autocatalyst sector offset declines in jewellery. The platinum market will therefore continue to be in deficit that will support a continuation of high prices. The prices will be highly volatile however with peaks and troughs driven by news of supply disruptions and/or changes in investment sentiment.
Palladium
Johnson Matthey's palladium story has some elements in common with platinum and some sharp contrasts. The key differences remain the impact of the Russian state stocks and thus the ongoing surplus in the market.
In 2007 supply and demand both rose, according to Johnson Matthey. Demand was up 3.5% with the 10.8% increase in autocatalyst sales partly offset by declining jewellery demand as stocks in China were sold off. Supply meanwhile rose at the faster rate of 8% due to heavy sales of Russian state stock. There was thus an increase in the surplus last year.
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Nonetheless the two palladium ETFs that were launched last year were successful, holding 280,000 ounces of the metal by the end of 2007 and 580,000 ounces by end-March 2008. Investor interest was probably driven in this case by the weakening dollar and by comparison with gold and platinum prices rather than by the fundamentals of the palladium market.
Looking ahead Johnson Matthey is quite bullish on the prospects for palladium use in autocatalyst and industrial demand. While the jewellery outlook is uncertain there is some optimism that jewellery demand could rise in the light of palladium's price advantage relative to other precious metals, the end of destocking in China and increased marketing of palladium jewellery.
Supply meanwhile could fall due both to lower output from South Africa in early 2008 and to reduced Russian sales as Russia now has foreign currency from sales of other commodities and so it has less incentive to sell.
On balance therefore Johnson Matthey expects a tightening in the market as demand rises while supply falls. The market will still remain in surplus however and investor behaviour will be absolutely key to the price evolution.
