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”.

 

 http://www.mining.com/chinese-tax-breaks-nothing-palladium-price/

 https://www.heraeus.com/en/hmm/market_reports/market_reports.aspx
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Platinum Sector Developments

Two developments have caught my eye today.

Firstly news that Miner Anglo American has come under pressure by its largest investor to sell its platinum mines to a state-backed vehicle. This has pushed the share price higher in early trading and it's no surprise given their open intentions to buy back platinum operations in the national interest. South Africa's pension fund the Public Investment Corporation (PIC) will likely not relent on this course given the delicate balance of platinum supply in the country. The PIC is reportedly looking to roll its other platinum interests into a new national mining company to rival the other majors in the country and this acquisition would fit the bill. Whether or not this deal ever comes to fruition it shows the appetite for platinum by national backed vehicles like the PIC. Given our profitable operations and low market valuation we may one day be the focus of a hostile takeover although more likely we will see institutional buying in the lead up to talks I would think. Despite being a small operation with limited future expansion prospects we are very profitable and would be a sensible addition to PIC's portfolio of assets given they are looking to sweep up platinum operations.

The second item for discussion is news that Zimbabwe are tightening regulations in the mining industry which will potentially impact platinum mine investment in the country. Zimbabwe produces around 8.5% of the world's platinum, the world's third largest producer and in terms of palladium is ranked fourth largest.

"A report by Reuters over the weekend says the draft bill, which has been more than a decade in the making, includes a provision that authorities will only issue mining rights to companies listed on the Zimbabwe stock exchange."

The majors operating in Zimbabwe are primarily platinum group metals companies such as Anglo American Platinum, Impala Platinum through its Zimplats subsidiary and Aquarius Platinum but none are currently listed on the Zimbabwe stock exchange. Foreign companies must also sell a majority stake (51%) to local investors under the country's indigenization laws. Recent developments suggest a deepening protectionist trend emerging in the country.

The Zimbabwe government earlier this year revoked the licences of all diamond mining companies operating inside the country. They consolidated diamond mining in the country's rich Marange fields under a state-owned entity. Foreign miners have also been ordered to return mineral leases which the state says is not being developed at 'a fast enough pace'. In January last year the country introduced a platinum export tax but suspended it once majors Amplats, Implats and Aquarius agreed to support local metal processing prior to export. Such government backed moves to control the industry heightens investor risk and will likely result in reduced investment, with neighbouring producers such as South African companies benefiting.

http://www.telegraph.co.uk/business/2016/08/14/anglo-american-board-resists-pic-bid-for-platinum-business/

http://www.mining.com/draft-bill-says-list-harare-want-mine-zimbabwe
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Weekly Market Summary 17/11/13

I am going to set a goal of writing a short market summary at the end of the week, focusing on certain events, notable market changes and significant stock or commodity movements in the past seven days.

Junior Mine Report 

I recommend reading PwC's latest Junior Mine October 2013 report in which John Gravelle highlights that it’s the junior mining sector that is suffering the most despite majors taking costly write-downs, suffering from weak commodity prices and a sector-wide confidence issue. 

Anyone trading AIM will notice the comparable to this ASX focused report in which PwC suggest junior markets have been plummeting since 2011 following a brief period of recovery after 2008 lows. The market valuations of the top 100 TSX listed mining companies has fallen over 40% annually for the second consecutive year. This is an accurate reflection of what has happened to valuations across AIM. 

The report makes for bleak reading with reports of cash, short-term investments and capital expenditures all down by hundreds of millions, with "explorers making up the largest share". But despite warnings from certain industry commentators such as John Kaiser, there have only been a handful of companies going under, with many able to reduce operating costs and conserve capital, 7 reportedly de-listed for adverse reasons. 

Margin Squeeze

The Footsie miners shed 2.4% to 16,131.09 in line with gold, platinum, copper and aluminium all falling. The only notable riser was iron ore. Margins are being squeezed across the board with Antofagasta suffering on its earnings update despite an increase in production. The same story was true of Vedanta Resources as revenue fell despite increased output. This is becoming a common theme amongst producers, those highly leveraged falling hardest.

One stock I like to follow, Avocet Mining (AIM:AVM) a West African gold miner completed the buy-back of a gold hedge from McQuarie Bank. They have a highly leveraged gold project at the Inata Mine in Burkina Faso which is struggling to turn a profit despite targetting 130,000 ounces this year. If they are able to survive in this climate then the chances are much improved for the likes of Amara Mining (AIM:AMA), another gold producer located in Burkina Faso. Avocet's total cash costs amounted to $1,195/oz in the third quarter whilst Amara are targetting reduced cash costs as it brings the Sega mine into production. It's total cash costs are expected to fall from $1,357/oz in the first half to below $800/oz in the second half. 

I've previously stated my position in Amara and still believe quarterly results (Q3) due this quarter will be considerably better than earlier in the year. To recap in Q1 2013 gross revenue of almost $14m, cash costs of $10.5m for a margin of approx $400/oz resulted in EBITDA of $3m. Amara expect costs will reduce to around $700-800/oz and with gold trading at around $1300/oz margins should be higher at $500-600/oz in Q3 results, potentially rising to $600-700/oz in Q4 results should gold bounce off the current support level.

"If we assume 15,000 ounces are produced at costs of $700/oz and a conservative gold price of $1300/oz, EBITDA of $8m is achieved per quarter. This increases to $12m if production reaches 20,000 ounces."

It seems I'm not alone in recognising Amara's potential as RDV Corporation, a majority owned private company run on behalf of the DeVos family who co-founded Amway, one of the largest U.S. private firms has taken a 21% stake through a share swap. Assets from their exploration company Amlib, including $10 million cash and a profitable drill operator are included in the deal. RDV have been actively investing in West African gold for over a decade but Amara is one of the first to bring in a major U.S. family fund. If Amara fall short of production targets only achieving 15,000 ounces and costs are reduced at a slower pace in Q3 realising a $500/oz margin they should still turn EBITDA of $6.7m

There is a concern that the gold price will fall further. Such a move would impact marginal producers and indeed is deterring investors now as gold toys with the $1,270 support level. What will cause gold to break out/down? This is a much debated topic and one that I would like to discuss another term. In the short term US jobless figures are likely to support the bearish case, the US continues to show signs of recovery. The strengthening of the US dollar alongside the monthly QE figure of $85bn has helped push US stocks to new highs. Is this the reason for gold falling? Perhaps not, but it goes some way to explaining why ETFs are being sold down on a huge scale.

What will cause a shift in sentiment? For one thing, we know the US debt ceiling is due to peak again in January so expect some market volatility. Many commentators also expect tapering of QE to begin early next year. There is an argument to be made for the physical demand which has increased yet again and is up year on year. This won't be a surprise to many, the East are buying physical. The West are still reducing according to the World Gold Councils Q3 Report, ETFs sold significantly higher than any increase in physical demand. Is there manipulation going on? Probably, and it stands to reason those selling will begin to reduce at a lower rate. US economic growth is expected to plateau at around 2% of GDP once QE draws to a close whilst their deficit reduction programme will actually begin to rise again in 2016 according to the Congressional Budget Office. This year’s lower deficit can be largely attributed to short-term economic factors rather than systemic reforms in the federal budget, for never has the deficit fallen from such a high level. The sign to look for will be an improvement in ETF positions in the next quarterly WGC report. 

Tips

- Amara (AIM:AMA)
I'm expecting a significant improvement in quarterly earnings as well as a more robust balance sheets thanks to the deal with Amlib for $10m additional cash. Any weakness in the price of gold is unlikely to reduce the impact reduced costs and increased production will bring. 
Target 18-20p before January 2014.

- W Resources (AIM:WRES)
Exciting quarter for W Resources as it nears completion in constructing its tailings processing facilities. The pre-concentration plant was expected to be complete in October and according to the company things are progressing on time and on budget. They will begin producing tailings from next month for a period of approximately 3 years at which point they should be in a positive to bring their flagship La Parilla Mine into production. 
Target 1.2-1.3p before January 2014.

- Tertiary Minerals (AIM:TYM)
Volumes have been increasing in recent weeks and the share price peaked at around 8p in anticipation of drilling results and resource classification due early next year. They recently completed a financing deal with YAGM. The MB Nevada project is expected to weigh in larger than the Storuman project which is currently Tertiary's most advanced deposit as historical drill data and two phases of drill-work is compiled into a JORC resource. Now I am no chartist but even I can tell the stock is in an uptrend so I would suggest interest will continue to grow as we approach the second set of drill results, followed by a brief period of consolidation as we await the JORC resource early next year before further gains as value is recognised.
Target 11-12p before March 2014.

Hopefully anyone following will be able to see how accurate these targets are. My strategy is threefold in this current climate - analysis of trends, volumes and catalysts. Ignore the 'company potential' if any of these factors change for the worse and take profits.