This column was originally published on RealMoney on Aug. 18 at 12:30 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.Traders have been focusing for months on gold and silver futures, shares and ETFs, but amid their spectacular run, another lesser-known metal market has been quietly and slowly building a base of support. It's not often discussed or recommended, but the market in palladium is fascinating for several fundamental reasons. This brief discussion can't do justice to all of the relevant factors; nonetheless, this should give you a solid idea about the potential of this wonderful metal.
Substitute for PlatinumThe price of platinum has exploded over the past few years. Futures have risen from about $335 an ounce in 1997 to a recent all-time high in the $1,340 area. As a sister metal of platinum, palladium can be used as a lower-cost substitute in some applications. With the price of platinum at such a high level, palladium's appeal has risen. Palladium futures haven't climbed as sharply as platinum; however, they have explosive upside potential. Futures skyrocketed from $119 in 1996 to an all-time high of $1,090 in January 2001. Since then, however, they haven't rallied nearly as much as platinum. Accordingly, there is considerable upside potential in the palladium market, particularly if the other metals continue their upward course. Whether metals will remain in bull trends or not is hard to predict, however, I believe the odds favor such a continuation.
Russian DominationIn my view, the fundamental driver of palladium prices isn't demand, but supply. More than 50% of the palladium on the market comes from one country, Russia (there is reason to believe that the figure may be even higher). Russia essentially has the ability to run the market by controlling the production spigot. It may not control the market entirely, but it is certainly the dominant force. Although there has been a futures contract for palladium only since the early 1980s, it has shown a very reliable and predictable cyclical pattern that has run approximately five to seven years from one low point to the next. Prices were at relative low points in 1985, 1991, 1998 and 2003. Statistically, this isn't nearly enough to hang your hat on, but it does show a relationship that could well be part of an underlying economic trend. Gold and silver prices have also shown cyclical price behavior, although not exactly the same length as palladium.
Two Stock PlaysMovements in palladium prices have sent shares of North American Palladium ( PAL) gyrating over the past few years. As can be seen on the chart below, North American Palladium rallied in an almost uninterrupted trend from a low of $2.20 in April 2003 to a high of $14.52 in April 2004. During this same period, palladium prices rallied from a low of $180 to a high of $344, which was nowhere near the large percentage gain North American Palladium enjoyed.
|North American Palladium |
|Stillwater Mining |
Consider the Risks, and Use a Timing Trigger for EntryNeither of these two palladium plays are investment-grade stocks. They are purely speculative, yet they offer a viable and lower-risk alternative to outright long positions in palladium futures. Given the risks, I believe the following actions are prudent:
- Consider long positions within the next few weeks as precious metals begin to bottom due to seasonal factors.
- Await a pullback in prices.
- Use effective timing triggers to enter (i.e., momentum and volume triggers).
- Trading volume has declined considerably lately for the two, with North American Palladium moving about 127,000 shares daily and Stillwater about 600,000 to 800,000 shares. Watch for a spike in daily volume as a technical indication of potential lows.
- In the event that new lows are made for this move without follow-through to the downside, the odds will favor a rally.