Does Platinum's Downward Spiral Present a Buying Opportunity or a Falling Knife?

By Nathan Becker
06 Oct 2008 at 02:00 PM GMT-04:00

Platinum group metals prices are falling faster than a runaway locomotive down a mine shaft. So is the smart money buying the value proposition or standing clear until the demand side is clarified?

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St. LOUIS (ResourceInvestor.com) -- Sliding auto sales and sour investor reaction to the financials crisis have slapped platinum group metals prices from an all-time high in March to their lower levels since 2006. The plummet of PGM prices is “just incredible,” said John Mothersole, senior economist at Global Insight, as the price of platinum fell Thursday to below $1,000 an ounce for the first time in more than two years and palladium now is worth roughly one-third of its 1Q08 value.

What caused the epic fall?

Platinum marked March with an all-time high price of $2,300 an ounce on the heels of a power crisis in South Africa that hampered production during the first quarter of this year. Palladium prices also climbed to a multi-year high of $600 in the first quarter.

Since then, the price of platinum has fallen nearly 60%, closing on Friday at $957 an ounce, and palladium sits at $201.85 an ounce.

The main industrial use for PGMs is in catalytic converters to clean up exhaust and reduce emissions in cars and trucks. As automotive sales numbers cramp, demand for those catalysts goes down, thus reducing industrial demand for platinum, palladium and rhodium.

High gasoline prices and the U.S. financial pressure cooker have kept consumers away from car lots as automakers reported sales during September dropped 26% from their year-ago levels.

“[Because people are buying fewer cars,] there are fewer catalytic converters, so less platinum is being used,” Mothersole said. “People are dialing down their consumption forecasts.”

Mothersole said declining auto sales aren't responsible for the brunt of the platinum selloff, though. He said hedge funds and exchange traded funds had been pouring money into PGMs beginning in 2007, but as the U.S. financial crisis caught up with investors, they cut back and eventually began selling.

“The liquidity crisis has caught up with investors,” Mothersole said. “Now what you now have is, instead of investors adding to their positions, they're selling material back into the market. They basically need to be in cash, and instead of being long, they're liquidating their positions.

“[Platinum and palladium] are being pounded by the extraction of liquidity from global financial markets, and they're feeling the full effects of that shift in sentiment.”

In a piece last week, Resource Investor correspondent Jack Lifton called attributing the free-fall of PGM prices solely to a downturn in automotive demand an “oversimplification.”

A market deficit

In June, CPM Group's 2008 Platinum Group Metals Yearbook predicted that platinum surpluses would shrink this year, driving prices higher. CPM Group forecast that first-quarter power shortages that cut production at South African mines could drop the country's production of platinum 1.4% this year to 7.32 million ounces.

Mothersole echoed the group's sentiments.

“Because of the electricity crisis in South Africa, it now looks as if we're not only not going to get an increase in platinum production, but that South African platinum production is actually going to fall slightly this year,” he said.

And although South African production levels are back to end-2007 levels after the country recovered from its power crisis, the kink in production will contribute to a market deficit in platinum this year, he said.

Price outlook: Has platinum hit a bottom?

That deficit, combined with several other factors, could mean platinum prices are on their way up.

As investors shake themselves out of the panic they've been in while Washington hemmed and hawed with a rescue plan for the financial industry, they could decide to get back in the game rather than needing liquidity, causing prices to jump.

“I think you've seen near-panic in the last three weeks,” Mothersole said. “At some point, when nerves calm down, you're going to see a technical bounce.”

Of course, auto sales could continue to nosedive, leaving industrial demand low and keeping prices where they are or driving them lower.

But if consumers do start buying cars in full force again, the desire for cleaner air and more environmentally friendly cars will keep PGMs in demand.

“The environmental concerns related to car use, ... that's not going away,” Mothersole said. “In fact, it's likely to become more stringent, especially in these rapidly growing markets like India and China. That by itself places a long-term market assessment of platinum in a very healthy position, I think.

“I have a hard time thinking there's a lot of downside potential at this point,” he said.

Does Platinum's Downward Spiral Present a Buying Opportunity or a Falling Knife?
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