Tuesday, 27 December 2016

Precious Metals Outlook – analysis and discussion

It’s no secret palladium has performed poorly in the lead up to Christmas. Since it peaked at $776/oz on 1st December, (60% up over 11 months) support has fallen away rapidly with the metal trading down at $654/oz. Platinum has by comparison enjoyed a relatively stable month having already fallen in the weeks earlier. The reasons behind this correction are at this point difficult to determine given lack of information but I doubt Nymex contracts demand for March delivery suddenly collapsed. More likely palladium prices are correcting their October-December rally, a move overdue given that other precious metals have been trending lower.

Around the 21st December an article titled ‘Chinese tax breaks do nothing for palladium price’ was published. This is the news that China has decided to extend tax breaks on the purchase of small vehicles into 2017. The Chinese tax rate on such purchases has been 5% since October 2015 and will be lifted to 7.5%, offering incentive as it remains below the usual 10% rate. Buyers pay the vehicle-purchase tax, which is applied to vehicle prices before the 17% value-added tax.

Many analysts were predicting the tax break would be left to expire at the end of the year and consequentially demand for small vehicles would be impacted. Approximately 75% of palladium demand comes from the auto-catalyst sector, specifically in gasoline engines and the two largest markets are the Chinese and US given diesel’s lack of market presence. Platinum loads are higher in diesel engines, but on a proportional basis demand from the auto industry is roughly 40% with jewellery responsible for the bulk of the remainder. So this move should be a positive signal for palladium in the short term as it will continue to encourage price-sensitive buyers of gasoline fed vehicles.

Moody’s Investor Service suggests the extension “should keep vehicle-purchase prices in the world number one auto market chugging along”.

The ratings agency believes owing to the tax-break extension, auto sales growth in 2017 could be higher than its previous expectation of 2.7%, which reflected the expiration of the tax break, although growth in 2017 will be slower given the reduced tax break and "potential pull forward of demand to 2016 from 2017 because of the expectation that the tax break would expire." While the US market has seen strong growth in recent years, China's car industry recorded a 18% jump in sales in June and may have grown by double digits during 2016 to more than 23 million vehicles.

Looking back a little further the Chinese government previously cut the vehicle-purchase tax to 5% from 10% between 20 January 2009 and 31 December 2009. It later extended the tax-relief period to the end of 2010, but raised the rate to 7.5% exactly as we are seeing now. The 2009 tax cut stimulated year-over-year auto sales growth to 45.5% in 2009 and to 32.5% in 2010 from 6.6% in 2008, according to the China Association of Automobile Manufacturers.

The markets reaction to the news suggests little short term impact, given buyers of palladium pushed prices to year highs only 2-3 weeks prior to this decision when it was expected the tax break would expire and auto-catalyst demand would subside in 2017. The market is instead being pulled higher and recently sold lower by greater forces and I’m of the view that short-term tax decisions bear little consequence to the trading price of purchasers who demand physical palladium. Norilsk are buying back palladium at spot prices to ensure long term stable supply to its customers and the transparency surrounding this development will no doubt be feeding into other investor rationale.

I would like to highlight segments of recent PGM market analysis released by Heraeus to close. Ongoing Dollar strength, the weakening Gold price, weak Chinese demand in the jewellery sector and a currently sluggish demand from the automobile sector, especially for diesel engines are the main reasons for current platinum weakness. Interesting to note the Platinum-Palladium spread fell to a level not seen since April 2002. A further convergence of the prices could therefore not be entirely unreasonable given stronger growth for gasoline engines in the coming year and the spot price is trading below major platinum producer costs. Last point worth considering “the Nymex short positions reached the highest level since February 2016, just under 1.28 million ounces.” How many more shorts will pile in now that Platinum are trading off 9 month lows?

Regarding Palladium’s recent surge to levels not seen since Autumn 2015 it should be noted that the news about restricted liquidity in bullion “is probably the main driver”. Rhodium is currently having its best quarter and according to the analysis even at current prices there is “a lot of buying interest” thanks to strong demand from the chemical and automotive industries. Iridium continues to trade at a high level also, with relatively small quantities traded at a very high level. Over the medium term liquidity issues “would indicate a further price rise”.

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