Market Insider Reveals a Potentially Explosive Move in PGM

Announcer:

Welcome to Money Metals Exchange's weekly market wrap podcast. Helping precious metals investors during these treacherous times. Now, here's this week's market wrap with commentary and analysis from the fastest growing precious metals dealer in America, Money Metals Exchange.

Mike Gleason:

Welcome to this week's market wrap podcast, I'm Mike Gleason.

Coming up later in the podcast, we have a terrific interview with David Smith of Money, Metals and Mining. And you definitely need to hear what he has to say about platinum and palladium. You might not normally pay that much attention to these metals, but they have been on the move lately. And that's a leading indicator of a potentially explosive move in silver.

But first, let's take a look at the weekly action in the metals.

Mixed signals. That's what precious metals are giving us as far as short-term trends are concerned. Gold is little changed for the week and for the year. Prices remain mired in an ever constricting trading range between $1,650 and $1,700, coming in at $1,669 as we're recording this podcast on Friday morning.

Platinum, meanwhile, broke through the $1,700 level, where prices had encountered resistance last month and currently trades at about $1,723 an ounce and looks to finish the week with a gain of better than 2%.

Both platinum and palladium are being boosted in part by strong demand from the automotive industry, and that should eventually help boost silver prices as well. For the time being, silver is showing less strength than platinum however. Silver entered Friday's trading down a little over 1% on the week and it currently sits at $31.45 an ounce.

Again, the markets are giving mixed signals short-term. The silver chart doesn't offer much in the way of clues as to whether prices are on the verge of breaking out of the current trading range to the upside... or will continue to consolidate and perhaps seek out stronger support at lower levels. Investors, as always, should remain focused on the fundamentals that drive long-term trends.

Turning to gold's fundamental drivers, the yellow metal is likely to be underpinned by strong central bank buying in 2013. Granted, the price action in gold has been lackluster so far this year – especially compared to platinum, which continues to outperform. Gold will really shine when investors seek a safe haven from the financial markets. People buy gold when they are fearful, and for the moment most investors are complacent.

We're still living in dangerous times, though, with a debt and monetary crisis looming when the chickens come home to roost on all the reckless spending and printing, all the reckless bailing out and propping up and over-promising that Washington has been engaging in.

In the meantime, Congress and President Obama are squaring off over the so-called "sequestration" that's slated for March 1st. Under the sequester, $1.2 trillion in spending would be carved out of the budget over a 10-year period. It sounds like a lot, but spread over 10 years, it's really not at all. It amounts to $120 billion per year, which only makes a small dent in the trillion-dollar annual deficits the government is projected to run. That's the best-case scenario for deficit reduction – one that President Obama and House Speaker John Boehner are both trying to avoid!

What they won't be able to avoid is the currency crisis that is in the making as a result of the runaway national debt they refuse to rein in, and the future unfunded entitlement promises they won't touch. As reality continues to set in with investors, gold and silver will continue to emerge as a better form of money.

Before we get into the David Smith interview, I have a quick product note. We still have a few remaining fractional gold Lunar Series coins from the Perth Mint. These beautiful 1/10th ounce and 1/4 ounce pure gold coins from Australia are available at a nice discount compared to the fractional gold American Eagles, but supplies are limited. GiveMoney Metalsa call at 1-800-800-1865 if you want to snatch some up while they're still at a bargain.

And now, without further delay, here is our must-listen interview with David Smith.

Mike Gleason:

It is my privilege now to be joined by David Smith, senior analyst at the Morgan Report, which is one of our sister companies' monthly publications titled Money, Metals and Mining. David is a wonderful market insider and a real student of all things precious metals, and we're very excited to get a chance to talk to him today.

David, welcome, and thank you for joining us.

David Smith:

Thank you, Mike, it's great speaking with you today.

Mike Gleason:

Well here we are in early 2013, and gosh, it's been nearly two years of consolidation in the precious metals markets, which is probably a lot longer than many would have expected. Now many may be frustrated or wondering why we can't seem to get any sort of sustained move to the upside in gold and silver, and for the moment we'll just concentrate on those two metals... I definitely want to get into the platinum group metals with you later on... but in terms of this consolidation period in gold and silver, give us your thoughts on where we are and where we're headed, because you really have a good big picture perspective on things that I want our listeners to hear.

David Smith:

It's a disclaimer that nobody can predict the future, but we all keep trying. But at the same time, looking at the big picture, I think all of the underpinnings that have led to the gold and silver and platinum/palladium prices rising pretty consistently over the years are still in place. In fact, many of them are even more pronounced now than they were before. The story is still out there.

Within the context of a secular bull market, you have pretty big swings in both directions. As you mentioned, the metals themselves have held up reasonably well, but the mining stocks have really gotten hammered over the last couple years, and the best of the best are down from where they were. I operate on the assumption that I can expect to see a 50 percent retracement in the price of some of the very best producers, and for an exploration company it could be a 90 percent drop. Yet those ones that are still good are still going to be around and come back, but it really is hard when you hold a position and you see these kind of drops.

But that's what's been going on, and we now have massive paper money being inflated all over the world to increase the price of assets, and not too many people understand the difference between inflated dollars and nominal dollars, but there is a big difference there and it's going to come out in the wash one of these days. So I'm still very bullish on the metals, and what I try to do is keep a little cash in reserve so that I can buy prices that go lower than I expected.

Mike Gleason:

I've heard you mention, you and others, about how we generally get our biggest move at the very end of these bull markets, so there is certainly a long way to run and those who don't have core positions are going to want to get in before that leg takes place because it can be explosive when it finally moves.

David Smith:

That is correct. David Morgan has discussed this for a number of years, and if you look back at the dot com mania in 2000, and if you look at housing, if you look at all of these things, you'll see that during the last portion of the move, and David likes to talk about the last ten percent in time of the move, you can see gains of 80 or 90 percent of what would be available for investors during the entire bull move. I think we're going to see the same thing in the precious metals. It's a few years off, but it is coming, and it's going to be pretty exciting. As Doug Casey likes to say, the easy money has been made, but the big money lies ahead.

Mike Gleason:

That's a great point, definitely something that people need to remember. When you and I were talking the other day, you mentioned some really exciting things going on in the platinum group metals, and you indicated that we could be looking at some really explosive things in that sector of precious metals. Talk about what you're seeing with the PGMs and what's got you so excited about those these days.

David Smith:

I've been quite fascinated with the PGMs, primarily platinum and palladium, for about the last year. I've looked at a couple of properties in North America that are quite interesting. I have been aware of the price movements for the last several years in the PGMs, and the interesting thing about them is that they often times will start a move before gold and silver do, so gold and silver have been kind of back in and filling in a wide range over the last almost two years now with a slight downward bias. Platinum and palladium struggled for awhile, but then a few months ago they started fairly strong moves.

We have here, now that we're talking, we have palladium about ... above $700 an ounce. We have platinum, which had been about $200 cheaper per ounce than gold, which is very unusual, has now regained itself to be more expensive than gold, and traditionally has run from $200 to $300 higher than an ounce of gold, and it's seeming to move back into that area again. It's now $40 or $50 dollars more than gold after languishing for about two years.

I kind of look at this as kind of an early indication of what we're going to be seeing down the line with gold and silver when they break out to new nominal highs at some point here going forward.

Mike Gleason:

Yes, I'm just looking here...platinum is up nearly $200 since the first of the year and we're just in early February. Palladium is up about 8%, making a run towards $800 again. Eric Sprott, who is definitely a big mover and shaker in the precious metals industry, he launched this Sprott Physical Platinum & Palladium Trust recently, so you know that's going to help with demand for the PGMs on the investment side. It's just going to get those metals on more people's radars.

David Smith:

I think you're right on the money with that. Then if you look at the supply side, the PGMs are quite interesting in that most of the production comes from a few areas. South Africa accounts for the lion's share of it, and then Russia, and then Zimbabwe. You take all that together, that's over 90 percent of the PGMs come from those two countries ... those three countries, each of which have their own unique issues, and all of which call into question the reliability of supply.

A market does not like uncertainty, and when the market is uncertain about things, the prices can get very volatile. I think you're going to see very big swings both up and down in platinum and palladium over the next few years with a very strong upward bias.

Mike Gleason:

Platinum is still several hundred dollars below its 2008 high. I think it got over maybe $2,300 an ounce, and when you and I were talking recently you mentioned palladium has gotten over $1,000 dollars an ounce, if I'm not mistaken, at some point in the past, because of supply shortages out of Russia. Was that about a decade ago?

David Smith:

I think it was around 2004 on that, and it went up to $1,080. It had been about $200 an ounce or a little less. That was driven by supply concerns. Ford Motor Company made a very large purchase of palladium and they bought, I guess, pretty close to the top on that. They ended up selling it a year or so later for a one billion dollar loss, so it shows that you don't have to be just the little people like you and I investing. Sometimes the big entities can make even bigger mistakes than we do.

Mike Gleason:

Yes, and that's an interesting point that they bought near the top. To Ford or the other automotive manufacturers, they don't really care what the price is going to be because they don't want to put themselves in a position where they can't make cars because they can't get the raw materials. It doesn't make a difference if it seems like it's a really high price at the moment. They're still going to hoard it, and obviously hoarding just begats more shortages and so forth. We could see that dynamic play out again.

But you mentioned South Africa, there's obviously a tremendous amount of strife going on over there with the labor issues they've been having. I think I read that over 30 people have been shot and killed by police during strikes. Do you think we could see maybe a nationalization of the mining industry over there? Because obviously, if that were to happen and we turn over a big industry to a government, that's probably going to hurt the production of the metal.

David Smith:

There are several things going on in South Africa in regards to the PGMs. All of them negative from the standpoint of reliability of supply. You have three or four companies accounting for like 90% of the PGM production in South Africa and about 70% of the world production, and you have the labor issues that you have referred to. There was a massacre last summer which killed 35 or 40 miners, and real enmity going on there.

There's a question of miners being paid more. They don't have the use of machines as much as we do in the west here. A lot of it is done by hand, and deep areas, dangerous areas for relatively low pay. These things are coming back to haunt the industry. Gold has been in a very serious decline production-wise in South Africa the last 10 or 12 years. The PGMs are kind of headed down that same rathole.

Also, a lot of the surface PGMs have been harvested, and so they're having to go deeper. In addition, the government itself, as you inferred, is doing some things that are inamicable to enabling these companies to be profitable. In fact, right now several platinum mines have closed their mines down because they're basically treading water in terms of making money, even at these prices.

The government is talking about having basically what would be an export tax beyond a certain amount on these companies so that it would almost limit what they could make with their profit regardless of how high prices go. You've got the taxing entity, you've got the systemic social issues.

Beyond the mining fraternity itself, the society, the vast gulf of the wealth between the rich and the poor, and I think this is going to be ... these things are going to continue to flare up over the next few years because there hasn't been any real important solution to the problems. All of these things and the extra cost, it costs more and more for energy to do this mining, all of these things are conspiring and moving in the same direction to make the reliability of supplies of PGMs, primarily platinum, from South Africa to be questionable at best.

This puts that uncertainty in the markets, and there are already small markets, even in relation to gold and silver, and so it's going to be really dicey and pretty fascinating for investors going forward. That's just talking about South Africa, not even discussing the unique problems that Russia and Zimbabwe have in regards to their own production expectations.

Mike Gleason:

Basically when you invest in those metals, you're betting on supply disruptions in some very tenuous parts of the world, which for my money seems like a pretty safe bet and we're seeing that play out right before our eyes, as you mentioned.

David Smith:

Right. You'll see some of these production curves go up from time to time. For example, it's pretty well-believed that the overhang in palladium that came out of Russia out of the Norelsk deposit is pretty much gone, and they were able to supply the market for a number of years and really keep a damper on prices. But it's widely believed that it's just not there anymore. Now they still have more palladium, but they don't have that stockpile, and so for palladium, really, really a wild card in that regard.

Of course, the problems in Zimbabwe with nationalization and this type of a thing. That's going to continue going on, all three of those issues, and something like six or eight percent of the PGMs are actually produced in North American entities. That's a pretty small amount, so this is going to be going on.

At the very same time that on the demand side, we're having increased demand from new entities, and also increased demand from industrial entities where about two-thirds of the actual consumption of the PGMs currently is.

Mike Gleason:

Getting into that, China, of course, is a major automotive consumer, and you just look at a place like Beijing, for instance, and I'm not sure how many beltways they're up to now around the city, but they're expanding the infrastructure all the time just to account for all the new automobiles on the road. So despite continued economic weakness in the western world, we've got a huge percentage of the globe over there in India and China where we've got the rising middle class, and the demand for automotives and just all resources is likely to continue.

David Smith:

They're used in the cars, as we use them over here, it costs about $200 to put platinum in for a catalytic converter, and both platinum and palladium are used as converters, and they have a certain inner exchange that they can use, one for the other. But platinum is primarily used in cars that run hotter, like regular engines like you and I mostly drive. Palladium works very well in diesel engines, and there's about a $1,000 gap there, with palladium being about a thousand dollars cheaper than platinum. We're getting strong demand from both diesel production and regular car production.

This is one of the things, I wrote a report last summer on a PGM property that I looked at in Yukon, and one of the conclusions that I came is what I called a triple demand bypass. The market was looking, at that time, of what was believed to be fairly substantial surpluses of PGMs going forward because the world was mired in a bit of a recession, and a lot of people were calling for an even deeper recession, so that people were going "oh, we're going to have a surplus here, no problem".

Also, a lot of the Japanese car parts manufacturers had been knocked out of action due to the Fukushima disaster and the tsunamis there, and so they were off-line in terms of production, and that was taking demand down. Then also there was a tailing off of demand from the investor side. So the assumption was that line of reasoning was going to follow out and we weren't going to have to worry for a couple years.

But what happened is that the market turned around more quickly than people believed, not only in China but also in the United States where we're having very strong auto production now. Suddenly, this demand was there, and then you had the issues of supply from South Africa questionable. Suddenly, all of a sudden we have Johnson Matthey coming out and saying we could have the lowest amount of PGMs available in the last 12 years. It was a complete 180 turn, and I think it really caught their market by surprise, and that's why you're seeing some of this catch-up going on in terms of prices, which have been pretty strong across the board for the last couple months.

Mike Gleason:

One of the reasons we like silver so much is the industrial component and the fact that we're always seeing new applications come out for silver all the time because of its tremendous use in the number of industrial applications. Do we see the same sort of dynamic in the PGMs or is it mainly just as catalytic converters and I guess some jewelry demand as well? Is that mainly what it is at this point or are we finding new applications for those?

David Smith:

An external look at the surface would indicate what you just said. We know that even today that two-thirds roughly of platinum and palladium are used in catalytic converters. But the reality, too, if you dig beneath the surface a little bit, you'll see that both of these metals are finding all sorts of increased usage and medicinal practices and in other industrial things.

Almost every type of cell phone and laptop and electronic device has some amount of PGMs in them, and these are mostly not retrievable. Now catalytic converters can be. That can be harvested to use a lot of that metal again, but not so much with these other things where a small amount is used. They're pricing elastic a lot like silver is. If you double the price of palladium or you double the price of silver, the people are still going to use it in there because they have to have it and because the price is a relatively small part of the total cost of that item, so they're not out too much.

I think we're going to see some of the very same dynamics, especially with palladium, as it narrows the gap between itself and platinum, that we see of gold ... excuse me, silver in relation to gold. I find the study of both of these to be very, very fascinating because we have new investment elements that were not even here a few years ago that are going to impact these metals and drive them much, much higher over time, even though we'll see big swings up and down in the interim.

Mike Gleason:

It's all fascinating stuff, and a lot of people don't really even give it too much thought, those that might just be focusing on gold and silver in the precious metals markets. The dynamics are obviously a little different for the PGMs, but that's why they can be great portfolio diversifiers for precious metals investors they really ought to take a look at having some exposure to the PGMs. There's potentially a lot of upside there.

David Smith:

That really is true, Mike, and for example platinum and palladium can be purchased just like gold and silver. They're called bullion rounds, and of course they even have some that are made in the United States, like the American Eagle, Silver Eagle, and Gold Eagle Series. You can buy Maple Leafs. Or you can buy just company rounds. On troy ounce. You can buy ingots.

More and more people are understanding that you can actually add these to your portfolio. There is an increasing, very heavy investment demand in China, not only for investment of the rounds that we've just been discussing and ingots, but also in jewelry. In China, the jewelry that is made out of the PGMs tends to be around 85 percent or higher purity, where as in this country you can buy gold jewelry, for example, that might be 20, 30, 40 percent still looks really wonderful, but they value the higher purity over there, so that puts an even bigger demand on what are very, very small markets.

Not to mention the rise of exchange-traded funds, which again are all pushing the demand place forward and taking more and more supply off the market, most of which is not going to be immediately available unless we see much, much higher prices.

Mike Gleason:

In closing here, David, I just want to get your take on what you think investors should be doing. Obviously, those that might have jumped into this market a couple years ago feel a little worn out just because of what happened in the long consolidation period that's followed that. But what sort of advice would you be giving people right now who believe there's something not right with the world and they do need to have exposure to something real, meaning precious metals. How much should they be investing and what type of approach should they be taking right now based on where we are in this bull market in precious metals?

David Smith:

Well, I think people have to really look at their own circumstances, their risk tolerance, what their goals are, and really the first thing about buying, especially silver and gold and even platinum and palladium, should be as insurance first. You do your research and you do insurance. This way it will protect the downside of some of your other assets as they lose value due to inflation.

But the big mistake that people can make, I think, is to get an idea okay, they listen to us and they're very excited about the PGMs and they want to go out and buy a bunch tomorrow. Well, they've already had a pretty substantial run here. Palladium was $200 an ounce lower just a few months ago. I did a look at five years of palladium prices.

To give you an example of the volatility, which I think is only going to get worse. This is five years of prices. $600 an ounce to $200 to $800 to $600 and now around $750. Those are huge swings. If somebody bought a couple months ago, they're feeling pretty happy, but if they go out and buy now at $750, it might drop to $675 and they're going to be dispirited.

So what I like to suggest is that when people do decide to do something, they don't go all in, but they buy tranches, a portion. If they have to be in right now, they would buy a portion now, and then they would buy a portion only at lower prices and only a third portion at still lower. Now those two may not be filled, but there's a good chance that at least one of them will be. And weanwhile, instead of feeling a panic when prices drop, you'll almost be hoping for lower prices so that you can fill the rest of your order rather than going all in, and then sitting there with no cash to buy at a lower price.

I think that's just as true in buying precious metals in the physical space as it is in the mining stocks, because the volatility in both directions is going to keep on getting more and more, but I do believe that people to take a modest position after doing their own research in this sector and hold on for a few years, they're going to be very, very happy.

Mike Gleason:

Well, David, thanks very much for your time and your excellent insights. That's great advice there and we definitely hope to do this again in the future. Thanks very much for coming on.

David Smith:

It was great talking with you today and it's going to be very exciting seeing where we go over the next weeks, months and years. I think it's going to be historic eventually at the end of this.

Mike Gleason:

Well, that will do it for this week's market rap. Thanks for listening. My thanks to David Smith of the Morgan Report, once again. This has been Mike Gleason with Money Metals Exchange. Have a great weekend everybody.

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