Were The Platinum Group Metals Afloat On An Ocean Of Asian Liquidity?

DETROIT (ResourceInvestor.com) -- During the summer I wrote here of the strong anecdotal case being made in Detroit that linked the sharp reduction, then underway, in the price of rhodium, as well as a more gradual decline, at the same time, in the price of platinum. It was due to an unwise and undisciplined inventory reduction by a major car company in the midst of its own 'liquidity' crisis. After the article came out it was pointed out to me by a prominent industrial, but non-automotive, buyer of rhodium that the rapid fall might have also have been due in part, or even all, to the collapse of the hedge fund run by Ospraie Management, which had a history of taking outsized positions and even physical possession of platinum group metals. I think that perhaps both of these causes, and more, were or are operating to cause the prices of the platinum group metals to 'correct.'

The overwhelming demand for the platinum group metals comes from the global, OEM automotive industry. So, in any event, if we are to understand the dynamics of the platinum group metals' markets it is first necessary to look at the total consumer vehicle production projected for 2008 even as late as six months ago. At that time everyone was predicting a 17 million unit year in the U.S. and a total of more than 85 million units globally. Of the 85 million total around 84 million would be powered by internal combustion engines burning hydrocarbons. The smallest of these passenger vehicles would use two-, three-, and four-cylinder engines and predominantlymade in China and India. They would not have been required to be equipped with exhaust emission control catalytic converter--utilizing some combination of platinum, palladium, and rhodium. The remaining volume of larger cars with more powerful engines, including essentially all of the cars and trucks made in North America, South America, West and East Europe, and Japan would, by law, require 'catalytic converters' in order to meet exhaust emission control standards. The total number of such units equipped with catalytic converters, of the 85 million projected then, w ould have been some 70 million vehicles.

The 2008 projection for American sales of new vehicles has shrunk down to perhaps as little as 11 million units; a loss of 6 million vehicles. The cause of this has been not only economic but also practical. American owned-and-operated OEMs as well as even some of their transplanted competitors from Asia and Europe simply do not have, in the case of the native Americans, and cannot make, in the case of the transplants, enough fuel efficient small cars to meet the new consumer demand for such vehicles. In Europe this is not the case nor is it in Japan. In those places it is economics, the availability of credit, that is the major factor in any decline of vehicle sales.

In the worst case for 2008 the global demand for new vehicles equipped with catalytic converters may go down by 12 million units of which 50% will be lost in North America alone. These 12 million units are around 15% of total formerly projected global volume for 2008. Admittedly the lost sales will be of the largest vehicles with the largest engines. Therefore we can say that the need for platinum group metals could decline by as much as 20%. Why then has the price of the PGMs declined by more than 50%?

Late in August an analyst at Canada's Royal Bank of Canada Commodity Management (RBCCM) group published a study for the bank's customers in which he estimated that the costs of producing one ounce of platinum were as much as $1,200 at AngloAmerican's highest cost operations in southern Africa. Ominously for the market, AngloAmerican is the world's largest producer of platinum metal. Therefore it's most likely also the world's largest producer of rhodium, since rhodium is overwhelmingly produced as a byproduct of platinum mining. In any case the estimation by the RBCCM study that AngloAmerican has the highest cost of production, per ounce, of platinum has had a very serious impact on the platinum group metals market. In my case, since the publication of the study, it has been mentioned to me as determinative of the PGM supply and price by every consulting client I have had during that period, without exception, and it has always been the client who brought it up first.

If, as it seems, today AngloAmerican is responsible for between a third and half of total new platinum production and if it is correct that Anglo's average cost of production of platinum per ounce is $1200 (USD) then the fact that platinum metal as of this writing (Oct 1, 2008) sells for $1,035 an ounce is a disaster for Anglo, because it means that if the company wants to keep its mines open it must stockpile (inventory) platinum and rhodium, or, at least, stockpile ore or ore concentrates. This, of course, means that in the middle of the worst short term credit situation in modern history the company must use its capital only to build inventory either of finished goods or work in progress unless it can both find buyers and is willing to sell at below market price. Since the primary use for platinum group metals today is for the construction of exhaust emission control catalytic converters for vehicles and since the vehicle manufacturing industry is experiencing its biggest downturn in recent history it is very unlikely that, even if the producer were willing to sell material below market, there would be buyers. The question therefore becomes why is a company like Anglo even continuing production?

The answer is simple and economically deadly. Production is continuing because shutting down the mines only marginally reduces the costs of operations by the cost of direct labor. You cannot shut down the air conditioning for the very deep and hot mines; you can only reduce its level so that the equipment in the deep mines will be kept from being harmed by the heat. You cannot shut down the mines' water pumps; their failure and the flooding ensuing of the mine workings would be economic suicide. Additionally maintenance crews must be underground for 'care and maintenance.' The current shortage of electric power in South Africa has meant, in actual practice, that power is flowing mostly to those end users producing the most export revenue and taxes. Until now, this has given the platinum group metal producers a clear edge over the producers of such materials as chrome, manganese, and the ferroalloys of both. At what reduced level of platinum-group metals operation this allocation of resources will change is an open question that adds more uncertainty to the future production of platinum group metals in South Africa.

Since fixed costs of idle operations are high, shutting down the mining and milling (concentration) operations actually adds costs which are cumulative and realized whenever the mine is reopened.

Therefore, lowering demand even by 20% simply cannot abate the accumulation of existing mines's costs; it can, however, cause a re-evaluation of developing new capacity. The reduction of demand, the dramatic rise in the costs of labor, electric power, and new equipment, and simultaneous evaporation of credit has in fact caused expansion plans to be put on hold at the world's largest platinum mines.

What of the future of the platinum group metals in the automotive industry?

Keep in mind that when the world's economy 'recovers' from the current overheating the growth of the BRIC economies and their demand for natural resources will resume with a vengeance, the vengeance of pent-up demand. Even if all of the most optimistic projections for the production of rare earth metals, nickel, cobalt, and lithium are realized the largest number of electrified cars of all types that will be able to be built yearly by 2015 will be less than 10 million. This may well be only 8% of the passenger cars and freight carrying trucks built that year. In that case, even though the average car built in 2015 will be smaller than the average car built today it will still be powered by an internal combustion engine burning a petroleum hydrocarbon fuel. There may well be 115 million such vehicle built in 2015 or 50% more that year than are now built. Even if the need for PGMs per smaller car is much less than that used now the total yearly demand for PGMs will be higher than it is now.

The long term future for PGMs is thus one of increasing demand in total at higher prices, due to rising fixed costs at the mines, than realized today.

In the short term however the reduced demand during the switchover of the global OEM automotive industry to a mix of small internal combustion engine powered cars and electrified cars of all types will keep the prices of PGMs low as compared to recent historical pricing.

In the U.S., Asian liquidity manifested itself as cheap credit and Americans went on a binge of buy-now-pay-later not only in real estate but also in durable goods and an ocean of cheap personal electronics. It was inevitable to those not in the managerial suites of America's banks and corporations that Asia would quickly assimilate engineering and production technology and move its capacity to the production of high quality durable goods. That day has now arrived, and the reckless squandering of American innovation by trading it at low or no value for cheap components and finished goods has eliminated, in the domestic OEM automotive industry,for example, any ability to compete on price with the tsunami of cars and trucks about to hit U.S. shores. Keep in mind that the seemingly bottomless pit of Asian liquidity showed up in Africa as a source of low priced investment capital aimed at securing natural resources as raw materials for Asian manufacturing. The resources were paid for, in part, with critically necessary infrastructure development. Part of, or even all of, the sharp declines in the prices of the platinum group metals may be due to the truly global nature of the credit (and therefore investment) shortage, part may be simply due to the redirection of Asian capital to domestic (i.e., Asian) development and away from not only further development of increasingly costly, and therefore marginal mines, but also of the infrastructure necessary for local investors to be able to compete.

The chance of the need for platinum group metals for exhaust emission control of internal combustion engines going away in the near future is zero. However, notwithstanding any possible percentage electrification of the power trains of vehicles the costs of producing platinum group metals may already be rising to the point where increased exploration and supply will be constricted or eliminated and production may in fact now decline. We are shortly, I think, to enter a period where the prices of platinum group metals rise steadily as they become truly precious yet remain critically necessary for the control of the environment.

About the Author
Jack Lifton

Jack Lifton is a leading authority on the sourcing and end use trends of rare and strategic metals. He is a founding principal of Technology Metals Research LLC and president of Jack Lifton LLC, consulting for institutional investors doing due diligence on metal- and material-related opportunities.

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