The mining and metals market is rife with analysts eager to speculate about how commodity prices will behave, but when the CEO of one of the world’s largest palladium producers says that the rapid rise in the precious metal’s price has created a “bubble,” the industry tends to sit up and take notice.

“It is a bubble, but… as new models get developed in the auto industry, adjustments will take place and maybe there will be some substitution there,” Anglo American boss Mark Cutifani told the FT Commodities Global Summit in March, referring to the fact that car manufacturers may choose to replace palladium with much cheaper platinum in their emissions-reducing catalytic convertors.

About 85% of palladium demand comes from the automotive industry and prices surged nearly 90% during the seven months to March to trade at a peak of more than $1,600 an ounce, as demand outstripped supply.

Substantial market deficits have led stockpiles of the precious metal to dwindle and lease rates – once palladium has cleaned out impurities from an end product (petroleum, pharmaceuticals or other chemicals), it is extracted from the waste by-product and re-introduced, meaning companies often lease it since they don’t need to own any more than they use – to reach unprecedented levels.

Prices have since fallen, but are likely to remain relatively high for a while as global automakers continue to favour palladium, despite the fact that at the time of writing, platinum is trading at almost $500 an ounce less.

“The comments by Anglo American’s CEO appeared to be a catalyst for the recent drop in palladium prices, but in reality the market has been easing for quite some time, which suggests the market was becoming increasingly investor-led – and perhaps a bubble,” says Ross Strachan, senior commodities economist at Capital Economics.

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“Month on month over the past six months, Chinese auto sales, a major market for palladium usage, have been coming in 10–20% lower year on year, and at the same time you have US and European automotive sales struggling as well, so it wasn’t a shock that prices moved sharply lower. Palladium is also one of the most volatile commodities and you often see sharp moves in either direction.”

Size matters: why is the palladium price so volatile?

That price volatility is in part down to the fact that the market for palladium is still relatively small and therefore investment levels have a bigger impact than they would, say, on markets for gold.

Strachan refers to this as “inelastic supply and demand” – in the context of the global palladium market, it means that car manufacturers are unlikely to swap the metal for platinum any time soon.

“Higher loadings of palladium and rhodium are required to meet emission standards in forthcoming legislation in Europe and China, which has led some auto companies to increase work-in-progress stocks in preparation,” he says. “Some are looking quite aggressively at reducing their palladium usage in favour of platinum, but it is likely to be at least 2–5 years before we see significant changes.

“Some of the larger players are aware that if they did revert back it could potentially change the dynamics of both markets – and potentially may cause the platinum price to go back above that of palladium. The large automotive manufacturers are not going to stop using palladium in their catalysts next week, next month or even next quarter just because of the price.”

Total recall: the Fiat Chrysler emissions controversy

In March, the latest chapter in the palladium story was written when Fiat Chrysler Automobiles (FCA) announced it was recalling 862,520 gasoline-powered vehicles in the US and 103,000 in Canada, because they do not comply with US Environmental Protection Agency (EPA) emissions standards.

Potentially, replacement catalysts for these vehicles could need around 100,000 ounces of palladium (equivalent to around 1% of global annual demand) and 25,000 ounces of rhodium (roughly 3%).

Strachan points out that FCA may have to use more palladium and/or rhodium than is the norm in order to be certain that it is compliant with the legislation. The EPA has also stated that it is checking other models and there is a risk that these could also be non-compliant, leading some to question whether palladium and rhodium prices could rally still further. Strachan is unconvinced, however.

“We think this is unlikely for three reasons,” he says. “The company started recalling the affected models in February. Accordingly, it is plausible that the company has already taken steps to ensure that it will have sufficient palladium and rhodium for the new autocatalysts. Therefore, this should already be fully priced into current prices. Indeed, given the speed at which the company has had to execute this change, it may have been a spur for the recent rally.

“Second, while FCA will need to use palladium and rhodium for the new autocatalysts, global supply will also effectively receive a substantial quantity from the recycling of the old catalysts. Therefore, the net impact will be a fraction of the gross demand pull – we would estimate less than a fifth – while the recycling and refining of the PGMs could create some bottlenecks in North America.

“Finally, these bottlenecks at autocatalysts recyclers and refiners of platinum group metals (PGMs) are likely to be eased by the fact that the EPA has agreed that the recall can be carried out in phases over 2019.”

A scrap over supply: production in Russia, South Africa and Zimbabwe

The US, Canada and Zimbabwe produce small quantities of palladium, but the market is dominated by Russia – prices spiralled in March when Russia’s trade and industry ministry announced it was considering a temporary ban on the export of precious metals scrap and tailings – and South Africa, who together are responsible for 80% of global production. However, the dynamics of the two countries are different in terms of investment challenges and opportunities, as Strachan explains.

“Russian production is primarily alongside nickel as a by-product, while in South Africa it tends to be produced along with platinum and other PGMs,” he says. “This can lead to a different investment rationale because it is not just your expectation of the palladium price that needs to be taken into consideration but of the whole basket of metals you end up producing. In Zimbabwe, the risk posed by resource nationalism is a little higher, but there is potential for long-term growth.”

Strachan points to another palladium trend that is likely to play out in the next few years, namely a significant shift in supply in the secondary scrap market, in particular scarp from auto catalysts.

“The upturn in palladium demand 15 years ago means an increasing amount of end-of-life vehicles have a significant amount of palladium in their auto catalysts, and they are being recycled,” he says.

We return to the subject of price and Capital Economics’ decision to revise its year-end forecast for palladium to $1,100 per ounce ($1,050 previously) and for rhodium to $2,350 (from $2,300).

“All in all, we think that the FCA recall will be a small net positive for demand,” says Strachan. “Given this, we are tweaking our end-2019 forecasts. However, this does not change our overarching view that the prices of both metals should fall substantially from current levels given the weak state of automotive demand in the US, Europe and, especially, China.

“Longer term, there is potential for palladium to recover in 2020–21 because heightened emissions legislation, particularly in China, means the market is going to require larger amounts of the metal.”