160805 precious metals watch palladium

Group Economics

Precious Metals Watch

Macro & Financial Markets Research

05 August 2016

Palladium rally run its course  Weak start of the year followed by stunning rally…

Georgette Boele Co-ordinator FX & Precious Metals Strategy Tel: +31 20 629 7789 georgette.boele@nl.abnamro.com

 …because of improvement in demand outlook…  …and general supportive environment for precious metals  We think that the upside is limited though...  …because fundamentals may not be that strong…  …and investors could lose interest

Sharp price rally since mid-June Last year, palladium prices dropped by almost 30% from just below USD 800 per ounce to USD 562 per ounce. This coincided with investors aggressively liquidating positions in palladium (futures and ETFs). This year, palladium prices had a weak start, but since midJune prices have rallied by more than 30% to above USD 700 per ounce (our year-end 2017 target). There are several reasons for this strong rally. First, the general trend in precious metal prices is positive. Second, investor sentiment has improved, supporting the more cyclical precious metals. The doom-and-gloom mood of just after the Brexit referendum has completely faded. Third, the outlook for the global car sector has improved compared to last year (when the emission scandal hit). Last but not least, wage negotiations in the mining sector in South Africa have fuelled expectations of possible strikes. In this note we answer the following question. Is the sharp rally justified or has it gone too far?

Net speculative positions vs palladium price In contracts

Palladium price USD/ounce

950

40,000

850

30,000

750 20,000 650 10,000

550

0

450 13

14 Net positions (lhs)

15 16 Palladium prices (rhs)

Source: Bloomberg, ABN AMRO Group Economics

Insights.abnamro.nl/en

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Precious Metals Watc ch - Palladium rally run its course - 05 August 2016

Increa asing role forr investors Of all the t precious m metals, palladium m is the one which is driven m mostly by cyclic cal factors such as a demand for a autocatalysts and a industrial demand. d Demaand for palladiu um is high if the glo obal economy g grows strongly resulting in a substantial s risee in industrial and a autoca atalyst demand d. Meanwhile, iff supply does not n rise as sharrply as demand d, palladium prices could rally sha arply. Over the e recent years, investor demaand has becom me singly importan nt. Investor dem mand is driven by different dyynamics than in ndustrial and increas autoca atalyst demand d and it is far more m volatile. Investors also taake into accoun nt central bank policies, p the US S dollar and the e attractiveness s of other cycliccal assets. The e most positiv ve scenario for palladium wou uld be if: -

gllobal growth is strong (boosting autacatalys st and industriaal demand),

-

de emand is large er than supply,

-

ce entral banks ha ave accommod dative policies

-

th he US dollar do oes not rally sharply

ectations aboutt the global eco onomy and carr sales in particcular deteriorate, investors If expe are the e first to react n negatively by re educing speculative positionss in palladium even e if actual demand does not fall that ste eeply. Moreove er, if investor seentiment is con nstructive adium investorr demand will likely be low. and other cyclical asssets offer greater return, palla Meanw while, if investo or demand dete eriorates, gold and to a lesserr extent silver are a more popula ar. In short, pal ladium as inve estment is highly leveraged too the outlook fo or the global economy but it doesn n’t offer income e in the form off a yield or a cooupon. As the graphs g below show, investorr demand has been the swing ging factor for tthe palladium market, m making g price behavio our much more e erratic.

Inves stor demand is the swinging factor In thous sand troy ounces

12,0 000 8,0 000 4,0 000 0 -4,0 000 00 01 02 03 0 04 05 06 07 08 09 10 11 12 13 14 15 16 Ind dustrial

Autocataalysts

Dental

Jewellery

Invesstor (CFTC+ETF)

Source: Source: Thomsoon Reuters Datastrream, GFMS, Bloo omberg, ABN AM RO Group Economics, E 2016 iis our forecast

Pallad dium price ra ally has run its s course Deman nd for palladium m has been larrger than supply since 2010, if we exclude flows f into futures s and ETFs. Be ecause of these favourable fu undamentals, innvestors were bullish for a long tim me. However, they abruptly changed c their minds m in 2015. This resulted in i a sharp sell-offf in prices. So w weakness in pa alladium prices s in 2015 was ppartly due to a less favourable fundamen ntal environment (larger mine e supply and thee emission sca andal) while investo ors also turned d their back on palladium, creating indirect ssupply as well (via ( the selling of investor po ositions).

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Precious Metals Watc ch - Palladium rally run its course - 05 August 2016

What are a our expecta ations for the remainder of 20 016 and 2017?? We take into account the following: 1.

Outlook O for car ssales

2.

Outlook O for indu ustrial demand

3.

Expectations of lower supply because b of, for example, strikkes at major mines

4.

Absolute and re elative price lev vels

5.

Overall O outlook ffor precious metal prices

6.

Outlook O for othe er cyclical asse ets

7.

US dollar outloo ok and easy mo onetary policy

For a start, s we expecct a mixed pictu ure for car sale es for the cominng months and d years. In case of o the US and JJapan, car sale es will likely sta ay around curreent levels but we w don’t expectt a substantial increase. The outlook for Eurrope is deteriorrating with the expected economy. In Emerging marke slowdo own in the UK e ets such as Chhina, India, Brazil and Russia a car sales cou uld improve tho ough. Moreoverr, industrial dem mand will be su ubdued due to the modest unconvvincing growth levels in the major m economiees. This is not an a environment that wou uld justify a sha arp increase in n industrial andd autocatalyst demand d expecttations.

In conttrast, palladium m jewellery dem mand will likely pick up from a very low level as higher gold and platinum priices could trigg ger substitution n into palladium m. Investor dem mand will be n. The main que estion we need d to ask ourselvves is if investo ors will a crucial driver again continu ue to invest in palladium as we w have seen so s far this year.. We think thatt if economic data co onfirm the pictu ure on unconvincing global growth, they wil l likely be less inclined to buy. They may even start to sell/tak ke profit on pos sitions bought eearlier in the ye ear. In additio on, palladium p prices have don ne quite a catch h-up so it is noot cheap anymo ore. ear, we expectt the Fed to kee ep interest rate es unchanged, which will likelly support This ye precious metal pricess in the coming g weeks and months. Howeveer, towards the e end of the year expectations of Fed rate hikes s could resurfac ce in financial m markets, suppo orting the US dollar and weighiing on precious s metal prices (we ( expect thee next rate hike e in Q1 2017). This will likelyy trigger a liquid dation of net-long investor pos ositions, resultin ng in lower precious metal pricess including pallladium. In Q2 2017 2 we expecct the environm ment in precious metals to im mprove again and a prices to ra ally. ntly, the investo or climate is su upportive for pa alladium prices but this could change Curren quite quickly. q If supp ly uncertainty starts s to fade and economic ddata in Europe disappoint, sentim ment could chan nge for the worrse. In short, we think that thee upside in pric ces is limited d. In contrast, a sharp sell-off is more likely than t a continuaation of this am mazing rally.

We ha ave adjusted ou ur palladium forecasts to refle ect this new reaality.

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Precious M Metals Watc ch - Palladium rally run its course - 05 August 2016

ABN AMRO precio ous metals fo orecasts Change es in red/bold New

End period p Gold Silver Platinum dium Pallad Avera age Gold Silver Platinum dium Pallad

05-Au ug 1,352 0.2 20 1,154 709

Dec-15 1,061 13.9 894 562

Ma ar-16 1,233 15.38 976 563

Q1 16 1,18 81 14 4.9 75 97 52 27

Q2 16 1,258 16.8 1,004 568

Q3 16 Q 1,374 20.0 1,084 649

05-Au ug 1,352 0.2 20 1,154 709

Dec-15 1,061 13.9 894 562

Ma ar-16 1,233 15.38 976 563

Q1 16 81 1,18 14 4.9 97 75 52 27

Q2 16 1,258 16.8 1,004 568

Q3 16 Q 1,374 20.0 1,084 609

Jun-16 Se ep-16 Dec-16 Marr-17 Jun-17 Sep--17 Dec-17 1,425 1,350 1,3 300 1,400 1,4 425 1,450 1,322 2 21.50 19.00 18 8.00 20.00 22.00 24.00 18.48 1,150 1,050 1,0 000 1,200 1,3 300 1,400 1,018 597 700 650 6 625 650 7 700 725 Q4 16 1,388 20.3 1,100 675

2016 Q1 17 Q2 2 17 Q3 17 1,300 1,325 1,3 350 1,413 18.0 18.5 1 19.0 21.0 1,041 1,025 1, 100 1,250 605 638 6 638 675

Q4 17 1,4 438 23 3.0 1,3 350 7 713

2017 1,381 20.4 1,181 666

Old

End period p Gold Silver Platinum dium Pallad Avera age Gold Silver Platinum dium Pallad

Jun-16 Se ep-16 Dec-16 Marr-17 Jun-17 Sep--17 Dec-17 1,425 1,350 1,3 300 1,400 1,4 425 1,450 1,322 2 21.50 19.00 18 8.00 20.00 22.00 24.00 18.48 1,150 1,050 1,0 000 1,200 1,3 300 1,400 1,018 620 600 5 580 625 6 650 700 597 Q4 16 1,388 20.3 1,100 610

2016 Q1 17 Q2 2 17 Q3 17 1,300 1,325 1,3 350 1,413 18.0 18.5 1 19.0 21.0 1,041 1,025 1, 100 1,250 6 603 638 578 590

Q4 17 1,4 438 23 3.0 1,3 350 6 675

2017 1,381 20.4 1,181 626

Source: ABN AMRO Grouup Economics

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