A recent surge in the price of palladium, a precious metal primarily used to help lower vehicle emissions, has investors looking at how to play the sector to potentially reap future gains.
The spot price for the metal hit a record high of US$1,565.09 on Tuesday amid threats of a strike at a number of mines in South Africa, one of the world’s top palladium-producing countries. A work stoppage would further reduce the supply of the commodity which is already tight as demand for the metal continues to increase. While the price of palladium has retreated from its high earlier in the week, it has increased by more than 20 per cent so far this year.
About 85 per cent of palladium production goes toward manufacturing catalytic converters, which help to reduce emissions from automotive exhaust. Demand has soared amid tightening emissions standards around the world, particularly in emerging markets.
South Africa and Russia together account for about three-quarters of global palladium production, while other sources are from Canada and Zimbabwe.
Norilsk Nickel of Russia is the world’s largest palladium producer, while other large and small mining companies have exposure to the metal. Toronto-based North American Palladium Ltd. describes itself as the world’s only pure-play palladium producer with its Lac des Iles mine near Thunder Bay, Ont., which produces about 2 per cent of the metal globally.
North American Palladium’s shares hit a four-year intraday high of $25.85 on Friday, which is an increase of about 140 per cent since the start of the year and a 160-per-cent increase from a year ago. Record palladium prices have given the stock a boost. The company’s board also declared a new 3-cent quarterly dividend on Feb. 14, alongside strong 2018 financial results.
Investors looking to take advantage of the commodity run-up should be cautious and consider different ways to play the palladium market, said Moez Mahrez, an investment analyst at independent firm 5i Research.
“When people start to hear about something, it usually means the momentum may be dying down,” Mr. Mahrez said in an interview. “At the end of the day, you are investing in a precious metal. It’s a commodity, so it’s a higher-risk, higher-reward type of play.”
He recommends investors looking to play the sector long-term start with smaller positions. “Investors may not want to put too much of one position into their portfolio,” Mr. Mahrez said.
For instance, Mr. Mahrez recommends investors consider some of the exchange-traded funds in the space, including the Aberdeen Standard Physical Palladium Shares (PALL), which tracks the palladium spot price using palladium bullion held in London, or the Sprott Physical Platinum and Palladium Trust (SPPP), which invests in bullion of both precious metals.
Mr. Mahrez suggests that, of the two ETFs, PALL is a better option because of its lower fee.
North American Palladium would be a good option for investors looking for a pure-play palladium producer, particularly since the company has cleaned up its balance sheet in recent years. “It’s a good option company-wise and exposure-wise,” Mr. Mahrez said.
Derek Macpherson, vice-president of mining analysis at Red Cloud Klondike Strike Inc., a Toronto-based boutique mining investment bank, initiated coverage of North American Palladium on Feb. 18 – when the stock was trading at $15.49 – with a “fair value” of $23.50 for the next 12 months.
Mr. Macpherson, whose firm recently helped North American Palladium raise money, cited in his initiation report “recent operating improvements” for the expected price increase, which have “materially improved operations” and a “solid growth plan,” that’s expected to generate additional free cash flow.
“They have a robust mine plan that definitely works at current metal prices but would work at much lower metal prices,” Mr. Macpherson said in a recent interview, adding that investors also have exposure to “one of the hottest commodities in the world right now. Our view is that it’s a fundamental move in the commodity, not just a short-term trading move.”
He said the recent commodity price increase was expected, “but maybe not this far, this fast.” Mr. Macpherson’s stock price projections are based on a palladium price of US$1,300.
Risks for the company include fluctuations in the price of the metal, as well as its tightly held capital structure. Brookfield Asset Management Inc. owns about 92 per cent of the equity after recapitalizing the company in 2015.
“Should Brookfield elect to reduce their equity ownership in a disorderly manner, we would expect this is likely to have a significant negative impact on the share price,” Mr. Macpherson said in his initiation note. “However, the past actions of Brookfield Asset Management and its related entities would suggest that this is unlikely."
In an interview, North American Palladium president and chief executive officer Jim Gallagher said the company needs to broaden its shareholder base given that Brookfield will eventually want to realize a gain on its investment.
The surging stock price, alongside a lift in palladium prices, is making the company look more attractive and people are paying more attention to the commodity.
“As soon as [palladium] gained parity with the price of gold, we got on the radar with a lot of people,” Mr. Gallagher said.
Meantime, Mr. Gallagher expects palladium prices to remain strong for years to come, citing restricted supply and increasing demand for palladium in catalytic converters in automotive gasoline engines as well as in hybrid vehicles.
“Part of the reason we declared a dividend is … we think the price will stay in this range long-term,” Mr. Gallagher said. “It may come down a little bit, but we are still talking being at parity or better with gold for some time to come.”