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RBC Capital Markets analyst, Leon Esterhuizen explains why the problems currently facing South African PGM producers and expected demand in Asia bode very well for metals prices.
GEOFF CANDY: Welcome to this week's edition of Mineweb.com's Metals Weekly podcast. Joining me on the line is Leon Esterhuizen - an analyst at RBC Capital Markets. Leon, you put out a very interesting note on the Platinum Group Metals (PGM's) market last week, the key point is that you expect that PGM's are going to do very well in the next three years. Can you perhaps take us through the thinking behind that?
LEON ESTERHUIZEN: Yes Geoff, it's really got to do with the fact that there's an extremely limited amount of scope for expansion on the supply base, while any number of forecast you care to look at, is looking at growth and demand. There are a couple of drivers there of course - in terms of supply you have to start by just looking at South Africa and its importance in that whole space. South Africa supplies something in the order of 80% of the world's Platinum - about the same or slightly more in terms of Rhodium, and about 40% of the world's Palladium. Now the only... South Africa is the Norilsk Nickel mine in Russia that supplies the other 45% of the World's Palladium, which really means that anything and everything that goes wrong in South Africa in terms of supply has a major impact on the supply/ demand balance for PGM's. It just so happens that it looks like the Russians have stopped stock-pile sales or strategic stock-pile sales. The stockpile sales of Palladium used to be in the order of 15% of total demand, and if you believe the Russians, they are basically saying that they don't have any more stock-pile to sell then there's immediately 15% out of the Palladium balance and that needs to be filled. The big question then is where is this going to come from - even at no growth there is 15% short in terms of metal. If you then look at the South African supply base - and you particularly look at the significant brewing problem of South African power shortages - I don't understand where we are going to be looking to find these expansions in ounces - yes there is some scope in Zimbabwe , and there is a little bit of scope in North America with North American Palladium expanding. But if I take this back to the demand side - and you look at the Chinese auto-market - it is expected to expand at about 15% this year which is down from 32% last year - that's about a third of the world auto-market - so 15% growth translates into about 5% car growth across the globe and we're not even talking about the US market that's growing, and the big countries etcetera. Assuming that about two-thirds Palladium goes into auto-cap demand, that 5% translates into something like 3.5% demand growth for Palladium, and again as I said we haven't put anything else into context here. The other thing to bear in mind is that China is currently sitting on average loadings per car of 2 grams per car in terms of Palladium in gasoline car catalysts, and that is expected to grow towards the 4 gram a car level over the next couple of years in line with where we are in Europe...
GEOFF CANDY: Has that got to do with emission standards now?
LEON ESTERHUIZEN: exactly - its emission standards. China is constantly trying to catch up to the West and they're actually catching up pretty fast. Just from the Chinese perspective - I'm not even touching on anything else - driving demand for Palladium by 3.5% per annum, plus the growth from 2 to 4 grams a car, you can easily talk 5% growth in Palladium numbers just on that basis. You need to put that in perspective, if you talk about 2% demand growth, you're talking about 150 000 ounces of extra Palladium required - one seriously big mine in South Africa will be producing in the order of 100 000 ounces of Palladium per annum, so we're talking about at least two big mines coming on line just to fill the next year's demand. There is obviously scope for some of these big companies like Amplats and so on to squeeze another 100 000 ounces out of the pipe-line, but it is extremely tight right now. I don't expect to see extra production coming on line, and in particular given the power situation in South Africa - it's summer now and we're already talking about a shortage, let alone what's going to happen when winter comes along, and the government by their own account, forecast September 2010 we will see a significant shortfall of power in 2012 and 2013. I believe things are going to get worse as far as power supply is concerned, and for that reason I just can't see the industry expanding at any meaningful rate. Clearly, if you are a big producer of cars, if you are a big auto company, or a country like China for instance, producing about a third of the world's cars right now, you must be asking yourself where you are going to get meta, given the supply side squeeze and the demand side growth expected. I would expect these people to start stock-piling metal, and if they do, that could have a significant impact on the price of Palladium in particular, and I would expect Platinum to follow, but Palladium is the driver at this point in time.
GEOFF CANDY: Are we going to see a lot more volatility in the price - if you've got companies looking to stock-pile as well as concerns and vagaries as to how much power we are likely to see in South Africa...
LEON ESTERHUIZEN: Without a doubt I'm expecting quite a fair amount of volatility in the price. Alarm bells should already be ringing, if you look at what General Motors did at the back-end of last year - they signed a metal.offtake agreement with Stillwater Mining Company without pinning the price, so basically saying "I want to sign a contract with you that says I will get metal from you, regardless of price." That already should start to make you wonder if a couple of other guys aren't going to try and do the same thing, or at least start stock-piling metal, and on that basis and with a clear view that the ETF's will continue to buy on the basis that South Africa has got issues with supply expansion ...
GEOFF CANDY: If we then take all of this to mean what you've been saying to mean - you like Palladium over Platinum, but in terms of the miners themselves are there any that are looking attractive at this stage?
LEON ESTERHUIZEN: Yes, the stocks obviously should be expected to trade higher if the metal price is going to increase, regardless of what happens to the rand almost. The better exposure should be to anything and everything that trades inside the PGM market, but not linked to South Africa. We believe that stocks like Stillwater and North American Palladium should outperform a South African based hands down given the constraints in South Africa, and the cost escalation in South Africa in particular. However, you can also buy the ETF's - even if you are in South Africa, as I believe you have access to ETF's - so we believe that the stocks should all trade-up on the premise that the metal price could spike from here, but I would expect you to get better returns outside South Africa than in South Africa.
GEOFF CANDY: Leon, just in terms of that investment demand, how is that likely to impact the price at this stage, clearly it is growing but is it likely to have a meaningful impact?
LEON ESTERHUIZEN: It's already having a very meaningful impact. I think the Palladium ETF position is currently two million ounces, with Platinum just over half that, but why would you sell your ETF position when there's growth everywhere in the world on the gasoline side, especially when you can see clearly that there's a brewing South African problem as far as power supply is concerned - that must cap supply growth, and if it doesn't it's at least going to cause significant cost increases given the guarantee 25% per annum cost increase from Eskom. I don't believe the ETF is currently at risk of selling-down, yes there will be volatility - we could drop $50 very quickly from here, but if you look at this thing over the course of the next three years, I don't see where the supply growth is going to come from, and given that view, the metal price is going to potentially have a nice spike.
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