LONDON (Reuters) - A jump in holdings of palladium-backed exchange-traded funds is ratcheting up pressure on a market that has seen years of deficit, threatening to push prices, already up by a third this year, higher still.
Palladium ETFs, which have seen hefty outflows since their mid 2015 peak of 2.6 million ounces, posted their biggest monthly inflows in more than three years in August. Holdings have risen again this month to hit their highest since January.
Graphic for Palladium ETF holdings rise in August: reut.rs/2xKEmsZ
Palladium prices do not always move in line with ETF holdings, as this year’s action so far shows, and after huge outflows in January, ETF demand for the year as a whole is still negative.
But with the market already in deficit in six out of the last seven years, even a small increase in interest in the funds, which issue securities backed by physical metal, could be significant.
“Last year, when ETF investment was going down, the deficit was being filled by investor selling,” Macquarie analyst Matthew Turner said. “If it’s a deficit market and investors aren’t selling, and there aren’t other stocks that can easily come to market, the only way out is that the price goes up.”
“We don’t even need to see massive investor buying,” he said. “We just need to see no investor selling.”
Palladium has hit a series of 16-year highs in recent months, peaking at $1,001 an ounce in early September. Short-term tightness in the lending market for platinum ingot, which pushed up lease rates, sparked an initial move higher in June.
Graphic for Palladium/U.S. dollar 3-mo FX forward swap vs palladium price: reut.rs/2jDVtXe
The rally has since pushed palladium to within $25 of parity with its rarer sister metal platinum, the narrowest spread between the two since late 2001.
While its spikes higher have largely been speculative, analysts say - net speculative length in NYMEX palladium contracts hit a three-year high this month - palladium’s broader move has been supported by underlying tightness in the market.
Graphic for Speculative net length in NYMEX palladium contracts: reut.rs/2xKwZ4W
Palladium is the most industrial of the major precious metals, with nearly 80 percent of demand accounted for by the car industry, which uses the metal in catalytic converters.
Stricter emissions standards, particularly in developing markets, and a shift away from diesel engines in Europe toward more palladium-intensive gasoline-fueled models helped push autocatalyst demand to 7.36 million ounces in 2016, a fifth straight record high. Those factors still apply.
“Tightening emissions standards mean that even if you have falling car sales, that may be outweighed by the fact that you have higher loadings per autocatalyst unit,” Societe Generale analyst Robin Bhar said. “We’re in a sizeable deficit, and we’re not easily able to grow primary supply.”
Historically, and unsurprisingly, there has been a clear correlation between autocatalyst demand and prices.
Automotive demand for palladium vs prices: reut.rs/2jEZ8Ei
Palladium autocatalyst demand is still expected to grow this year. GFMS estimates that palladium will be a deficit of some 1.4 million ounces this year and next.
Graphic for Palladium market balance since 2001: reut.rs/2jF8iRd
“The market just seems tight. Prompt deliveries are expensive, reflected in the forward curve being in backwardation up to June next year,” GFMS analyst Johann Wiebe said.
It expects prices of the metal to average $1,000 an ounce in the final quarter of this year, and to remain above that level, on average, through 2019.
Reporting by Jan Harvey; Editing by Mark Potter