The recent weakness in many precious metals has led some to believe the investment opportunity in that sector is over. However, I don’t believe that’s true—not all of the precious metals have the same fundamental drivers and thus have had varying levels of performance.
While some precious metals, such as silver, have dropped over the past couple of months, palladium continues to remain very strong. This strength is driven primarily by fundamental demand, especially in the automotive sector. Palladium is used in catalytic converters fueled by gasoline, the primary fuel in North America.
As you may or may not be aware, vehicle sales in North America are currently very strong. This strong level of sales is based on several factors, including a fleet of cars that is extremely old, low levels of interest rates providing cheap financing, and an economy that is beginning to recover.
The investment opportunity for precious metals that are primarily used for wealth preservation is almost impossible to predict, since a large part of the market simply holds on to the commodity without actually using it. However, there are some precious metals that are used for industrial purposes that have much easier methods of measuring their investment opportunities.
Palladium, for example, is one of the precious metals that have a calculable demand. According to LMC Automotive, they predict vehicle production in the U.S. will reach 16 units this year, making it one of the strongest in the past decade. So strong, in fact, that LMC reports that the current level for vehicle production is almost at full capacity! (Source: Sedgwick, D., “N.A. Output will reach 11-year high,” Automotive News, June 10, 2013, accessed June 11, 2013.)
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This strong demand will create an investment opportunity for certain fundamental inputs such as palladium. Because palladium is used primarily in gasoline-powered engines, the level of vehicle sales in North America provides a correlation. While other precious metals might fluctuate in price based on difficult-to-predict drivers such as institutional demand, the investment opportunity for a commodity like palladium is easier to determine.
The chart for the spot price of palladium is featured below:
Chart courtesy of www.StockCharts.com
The investment opportunity for palladium has clearly not been lost on investors, which is evident from how this commodity has outperformed many other precious metals. With demand set to continue rising, it appears that of all the precious metals, palladium is on course to continue its strong gains on a relative basis.
However, all of this could change once the monetary stimulus begins to be reduced. We are already seeing interest rates moving up, as the market is anticipating such a move, which could hurt vehicle sales. Over the long run, the vehicle fleet in North America is quite old and will eventually need to be replaced, providing an investment opportunity for precious metals that are an integral part of the production process.