Forgotten Platinum Group Metals: Rhodium and Palladium

ello everybody and welcome back to Breaking the Dollar. I'm your host Everett Millman. This week's episode is going to be reprising a topic that we covered a few months ago about, platinum and palladium. They're sort of the forgotten precious metals. But last time I just focused on why they are grouped together with gold and silver as precious metals. This time we're throwing in one of their close relatives, rhodium, another what you could consider a precious metal, but really the whole point is that they are industrial metals. And they've been in the news a lot more recently. That's what will happen when your price skyrockets by so much in a very narrow window of time. Which is what we have seen for both palladium and rhodium. This obviously begs the question: why?

To answer that we have to know the ways in which they are different from gold and silver and the ways in which these metals are similar. The biggest difference is that none of these metals are really used for jewelry purposes or even for investment very often. Gold and silver both have a rather long track record in this regard. But the platinum group metals are definitely more obscure. That belies the fact however that they are very critical components in a lot of industrial processes. To a small extent we do obviously see platinum used as jewelry sometimes, but that makes up a very small portion of its demand and even less so for palladium and rhodium. The best way to think of it is as the industrial side of the precious metals. Together these are grouped as the platinum group metals along with iridium and some other even more obscure metals out there on the periodic table. And for all three of them the main industrial use is in the automobile industry. Although it's not used in the amounts that platinum and palladium are, it has some pretty special properties in terms of being non-corrosive. So rhodium is very useful in a volatile hot environment like the components of your car. It won't wear away as easily and protects the other metals and parts. All of these metals are also very good catalysts, which is a kind of scientific way of saying that they enhance or cause chemical reactions with other metals and chemicals.

So what that means is that even if it seems like the rise of electric vehicles would put a big dent in the amount of these platinum group metals that are needed by industry, in fact, along with silver they are used for a lot of the electrical components that are in electric vehicles. There's even research and development into fuel cells for electric cars that use platinum as a catalyst. So both of these very large trends in the automotive sector with respect to these metals are being driven by the emissions control regulations. Whether it's through electric vehicles or normal combustion engines, if you want cleaner emissions in both cases you're going to need more of these metals. That in my view is the kind of exciting case to make for why we should be bullish about these metals.

It doesn't however really entirely explain why the prices have gone up so much. That side of the story is really about supply constraints. And this problem goes back to about 2017. It's been going on for almost three years. Not only are all of these metals exceedingly rare, so there's not that much of them in the ground to start with, but there have also been labor stoppages at the mines in South Africa where a huge proportion of the world's supply is mined every year. The only other major source really is Russia. There are some mines in North America that produce palladium as a byproduct of nickel mining. But the vast majority of the world's supply comes just from Russia and South Africa. Again because these metals are so rare and it takes a lot more time for them to accumulate.

This has started to cause problems with the storage of these metals. Most of the vaults where palladium and rhodium and platinum are kept are in London overseen by the London Metals Exchange, the LME. And evidence of the supply crunch can be seen in the fact that the lease rates, basically the interest rate charged to hold your palladium in London, has spiked several times in the past 18 months. At times the one month rate has been as high as 35% or more, which is incredible. Now it's only done so briefly but these rates are still elevated. Anything above 10% is dramatically high and they have been north of that for basically the past two years.

But what's interesting, to bring it back to the point of how are they different than gold and silver, is that palladium and rhodium especially are much, much more volatile in terms of price. By contrast gold is very stable and durable in terms of its long term volatility. Sure there's some volatility in the short run like the price of anything but it's nothing compared to the swings that we've seen so far in the platinum group. Just to give you some perspective and context, consider that since its 2016 low, palladium is up more than 400%. It has gone up 5-fold. In an even shorter amount of time, just since 2018, rhodium is up 350%. It went from below $2,000 an ounce to as high as $9,000 and given what we know about how these are largely industrial metals, that causes a lot of problems for producers who use it. Any manufacturer who needs palladium or rhodium now has to totally rearrange its forecasts for pricing because they buy these materials years ahead of time obviously.

For instance something that you would expect to see is that if palladium got so expensive at some point auto manufacturers would replace it with platinum in their catalytic converters. But not only does a change-over like that have to come many, many months or even more than a year ahead of time, but it is complicated by the volatility. So if you go back 8 and a half years ago around 2011-2012, the price of platinum was over $1,900 an ounce. It is around half of that right now, so it has lost 50%. And over much of that time the price of palladium was only around $500 an ounce. Now palladium is $2,500 an ounce. It is more than twice as expensive as platinum. But a decade ago it was only one-fourth the price of platinum.

Those types of wild swings in relative asset prices never really happens with gold. That is one of those things that makes gold unique. It is a pretty stable yardstick relative to the prices of other things. But obviously it is not so simple for the auto industry to just wholesale change over and convert to using more platinum in all of its different devices like catalytic converters. Because maybe a decade from now it shifts back in the other direction. It is not a given historically that palladium will always be more expensive than platinum. And vice-versa, the reverse assumption has obviously been disproven. So that makes it very tricky. From that perspective I have been expecting the palladium price to correct back downward or for platinum to close the gap. But so far neither of those trends have really materialized. It doesn't mean they never will in the future. It just goes to show the market for these metals is very different from the traditional precious metals like gold and silver.

And that is pretty much the story of rhodium, palladium, and platinum. I'll move on to our mailbag to see what question we got from a listener this week. This one comes from Seth in Barry, Ontario. That's Canada. Seth says, hello I trade the SPDR Gold Trust ETF GLD. What reason would I have to ever buy physical gold? That's a very common question because more people get exposure to gold by trading the gold ETF GLD, the one that Seth mentioned here. It is kind of funny to me that so many more people trade or own or think they own. I should say electronic gold rather than the real thing. The biggest advantage to holding physical gold, even though you have to take on the liability of storing it, all comes down to counterparty risk. What this means is if the other party in a trade the other person you are trading with defaults on their position. In other words, you have a paper or electronic claim to something, a financial claim, but the value of the thing on the other side of that that you have a stake in goes to zero. It becomes worth nothing. In most cases, that's just because the other person couldn't come up with it. They were the ones who didn't have the money.

But that is the general idea and some amount of counterparty risk plagues all forms of money and financial assets. Gold carries the lowest amount of counterparty risk so long as you physically own it. This is because you actually have the gold. It will always be worth something in every culture. Therefore in theory, you never have to worry about somebody defaulting or something becoming worthless. I know that can sound like maybe it's a trivial difference between an ETF, but it is certainly the safer way of holding gold. Not only is the level of counterparty risk in any ETF essentially the same as an equity, as a stock in a company, but in the fine print of the GLD prospectus, it even says that you can never take delivery or demand the physical gold you supposedly own. You cannot redeem your shares for actual gold unless you are an authorized participant, which is only a market maker, a big bank, etc. So if you're the average investor, your GLD share can never be converted into physical gold. Although that may not be your plan and most people don't use them that way, that is definitely something to know.

That's it for this episode. I want to thank everyone out there for listening. We appreciate everybody in the audience every time you tune in