The Metals Report: Your report, Platinum and Palladium, predicts a 915,000-ounce (915 Koz) deficit in platinum and palladium this year. Does your investment thesis treat the platinum group metals (PGMs) more as precious or industrial metals?
Rick Rule: The answer to that is both. PGMs share the same investment characteristics as bullion. For centuries, PGMs have been a means of exchange and a store of value. Platinum and palladium enjoy the monetary attributes of bullion, just like gold and silver. But they also have industrial utility. Unlike gold and silver, which have large above-ground inventories, the above-ground, refined inventories of platinum and palladium have largely been used. There is less than 12 months’ fabrication demand left in the world supply. Platinum and palladium go out a tailpipe, up a smokestack or get turned into high-value jewelry. Some people suggest that jewelry is still supply, but I know my wife does not consider her jewelry to be supply.
TMR: Other than the above-ground supply issues, how do PGMs differ from silver, which is considered more of an industrial metal?
RR: They are very different in that the above-ground supplies of silver are still fairly substantial and, in many people’s minds, silver is a precious metal. Financial investors and individuals hoard substantial amounts of silver, particularly in South Asia, where silver is regarded as a store of wealth. Covert or hidden supplies do not exist in the PGM industry.
TMR: Are the issues that would make PGM prices rise related to supply-and-demand or to its bullion characteristics?
RR: Definitely supply-and-demand. While it will benefit from factors that move the bullion price, notably the deterioration of the U.S. dollar, the real case for an escalating PGM price is the supply structure. The price also relates to the extraordinary utility afforded by platinum and palladium, particularly with regard to catalytic conversion. There is a social equation: platinum versus smog. Despite reasonable progress in air quality in the Western world, there is consistent social demand for better air quality, which means more use of platinum and palladium.
TMR: Are there substitutes for platinum in catalytic converters?
RR: There is no substitute at an equivalent price point. The most directly applicable substitute is gold, which is also expensive but much less efficient in the catalytic conversion process. Theoretically, you could use nickel for some processes, but it is much less efficient.
The substantial air quality advances in the last 40 years are the consequence of small amounts of platinum. It takes only $200 worth of PGMs on a new vehicle to give us the air quality we enjoy now. If you doubled the price of PGMs, the cost of a new $27,000 vehicle, which is the median sticker price of a new car sold in California, would increase only marginally. The utility of platinum and palladium is so high that the price can go up.
TMR: Looking at the supply side, the British Geological Survey gave PGMs very high risk in terms of supply, partially because of political issues in South Africa and reserve issues in Russia. It predicts a possible 10% drop in world production. Is this a temporary supply issue?
RR: I think it is a temporary issue that will be solved by price. And while the British Geological Survey research is forward thinking, it is out of date. Because the industry does not earn its cost of capital, South African production has fallen 19% in the last six years. That is a critical statistic because South Africa contributes 70% of the world’s new mine supplies of platinum and 30% of the new mine supplies of palladium. Production is already falling. While we have found small amounts in Canada, Brazil and Australia, three countries—Russia, Zimbabwe and South Africa—account for 90% of the world’s new mine supply.
TMR: Is there geological evidence to support the potential for discoveries elsewhere?
RR: There will be a furor associated with increasing platinum and palladium prices and money will be made in exploration speculation in other places. Lots of platinum and palladium is still available in South Africa, Zimbabwe and Russia; it just requires a higher price. It is very likely that most of the platinum that we will be using 50 years from now will be found within the shadow of a headframe in existing locations. There are three discoveries on the horizon, two in South Africa and one in Russia, that will help us with platinum supply 10 years from now. The question is how to get from here to there.
TMR: Prices have been extraordinarily volatile in recent years. Will that continue, or will the increase be gradual?
RR: I expect a lot of volatility, mostly to the upside. The reason for this is simple: the industry does not earn its cost of capital. Look at South Africa, where the industry itself estimates it is $6 or $8 billion ($8B) behind in sustaining capital investments. As a result, the industry has not made the investments necessary to reach parts of the ore body that have not yet been accessed. This has manifested itself three ways. One, production cost goes up as a consequence of infrastructure-bound mines. Two, production declines. Finally, mine safety standards fall, which has manifested in increasing worker mortality in South Africa.
The South African platinum mining business is labor-intensive, not capital-intensive. And the working conditions and the pay workers receive are deplorable. Workers’ wages have to go up, but cannot because the industry does not earn its cost of capital. Same thing for sustaining capital investments—there is no money. Finally, there is widespread political and social acceptance that the government’s take by way of taxes, royalties and rents, has to go up.
If you take those three factors—deferred sustaining capital investments, increased worker compensation, and increased social take—the industry finds itself between a rock and a hard place.
TMR: What price would enable more capital investment and higher wages?
RR: We think a move in the platinum price from $1,650 to $2,700–3,000 would allow the South African platinum industry to earn its cost of capital, provided the increase in the social take was moderated.
The difficulty is that the demand for platinum is so high that the price will overshoot in the near term. Making the $6–8B in capital investments to maintain production in South Africa would take six years. These long lead times in a capital-intensive business underscore the likelihood of extraordinary price moves.
TMR: When might we reach or overshoot that potential price?
RR: I think it will happen in the next two years, given that we have used up the above-ground inventory and that we need to maintain the current auto fleet.
TMR: Once the price reaches $2,700 in the course of five years, would you expect the additional revenue to go back into South African mines? And would supply then increase to meet demand?
RR: I cannot guarantee that in five or six years, but I can guarantee that the problem will solve itself over 10 or 15 years, which suggests that this investment thesis has a lot of running room.
TMR: Given that the industry does not make its cost of capital, how are the mines staying open? Which are making enough money to continue production through this timeframe?
Norilsk clearly earns its cost of capital. Its problem is that as you get deeper into the Norilsk ore body, the concentrations of palladium in the ore decline. Stalin opened these mines 80 years ago and the problem is technical: As you get deeper, the platinum and palladium run out. But Norilsk is profitable.
The other three—Angloplats, Implats and Lonmin—do not earn their cost of capital. Angloplats has some highly profitable operations, but they are dragged down by deep traditional narrow-vein operations, which cost money.
Sylvania Platinum Ltd. (SLP:LSE) is a small South African junior that produces probably 60 Koz/year. It is a tailing reprocessor, not a primary producer, but it earns its cost of capital. But it is a small company, probably $40–45M market capitalization. While not an efficient investment vehicle, it is a reasonable speculation.
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