Palladium left out of precious metals rally; investors shy away

* Palladium lagging gains in gold, silver, platinum

* Investors still shunning palladium-backed funds

* Investment needed to push market higher

* GRAPHIC-Palladium ETFs vs

* GRAPHIC-Palladium ETFs vs

By Jan Harvey

LONDON, May 17 (Reuters) - Investor appetite for palladium-backed exchange-traded funds is failing to pick up after a dismal 2015, pointing to another difficult year for the metal despite the prospect of a deepening supply deficit.

Market watchers are predicting the market shortfall for palladium will grow this year as mine output abates and demand from carmakers picks up.

However, its prices have lagged the rest of the precious metals complex this year, rising 5 percent versus a 20 percent jump in gold and 17 percent climb in platinum.

Palladium has missed out on the inflows into physically backed ETFs -- which issue securities backed by physical metal -- that have benefited gold, silver, and, to a lesser extent, platinum this year.

“It is a big concern,” Julius Baer analyst Carsten Meneke said. “Palladium had been a consensus bullish call for quite some time, and our fear was always what would happen if investors lost patience with that call.”

While many analysts predict the gap between underlying supply and demand will get bigger, changes in ETF holdings -- often counted as stock moves rather than a fundamental factor in the market balance -- could offset that, he said.

“The decline we’ve seen from the 2015 peaks of 3 million ounces to 2.2 million ounces represents a move from an under supplied market to a balanced market. That takes away some of the bullish narrative from the palladium story.”

Gold ETFs saw their biggest quarterly inflows since 2010 in the first quarter as prices rose by the most in nearly 30 years.

Regulatory filings showed billionaire investor George Soros and other big funds returned to the metal for the first time in years, though gold bull John Paulson cut holdings of his Paulson & Co fund.

Global palladium ETF holdings however have fallen by a just over a quarter since the middle of last year, with the bulk of outflows reported from the Johannesburg-based ETFs that launched in 2014.

That followed a drop in rand-denominated palladium prices to a two-year low of 6,770 rand an ounce in August.

“When a price goes down enough, at some point you just have to cut your losses and liquidate,” Metals Focus analyst Nikos Kavalis said. “A lot of these positions were built when the price was significantly higher.”

Inflows into palladium ETFs reached nearly 1 million ounces in 2014 after the launch of the new South African funds. With those reversing, palladium has lost an important area of demand.

Holdings have crept up from their first-quarter lows, but they remain down nearly a quarter of a million ounces from the start of the year and are languishing near two-year lows.

Without a more sustained improvement, palladium will continue to lag.

“Neither platinum nor palladium has got sufficiently strong fundamentals on their own to keep prices moving upwards from where we are,” ICBC Standard Bank analyst Tom Kendall said.

“A combination of improving fundamentals, whether from continued restructuring on the supply side or better demand growth, and a continuation of the recently rediscovered investor enthusiasm is needed in order for prices to keep rising.”