By Michelle Smith-Exclusive to Palladium Investing News

Look at palladium's figures and you are likely not impressed as the metal lost 20 percent of its value just last month. After stealing the show in 2010 with a 95 percent gain in value, it may seem like a fad metal whose heyday has passed. But, you may not want to be too quick to write palladium off.

Auto industry improving

Yes, some analysts have cut their outlook for palladium prices in 2011.

James Steel, precious-metals analyst for HSBC, downgraded palladium from $825/oz to $785/oz.  However, Steel is a member of the crowd expressing optimism for the metal in 2012. He believes palladium may then rise to $810/oz.

Such optimism is largely based on what Johnson  Matthey, a global leader in auto catalyst production, described as “clear signs the auto industry is on the front foot again.” A rise in sales has been noted in developed economies such as Canada and the EU and emerging markets are also expected to continue displaying a healthy appetite for vehicles next year.

Ford, for example, is betting heavily on sales from Russia and has announced vehicles specially designed for Indian and Chinese consumers. China, according to Johnson Matthey, now has more vehicles on the road than any other country except the US and is still viewed as a growth market.

Gasoline engines and emissions standards

The connection between vehicle sales and palladium is important because the automotive industry consumes about 60 percent of the metal's annual supply for use in emissions systems. A report by Johnson Matthey says that in 2010 only a few auto makers still used platinum in vehicles with gasoline engines, though platinum was once the predominant metal for this purpose.

Palladium is not as easily substituted in diesel emissions systems due to differences in the combustion of the fuels. But, even in diesel vehicles, an increasing amount of the palladium is being used and development efforts continue in hopes of further improving the substitution ability. Where palladium can be used as substitute, the switch is likely to be made as it is about half the price of platinum.

Diesel vehicles are still preferred in the EU, but many of the other large or growing auto markets are predominately gasoline, including the US, China, Russia, Brazil and Japan, which provides strong support for palladium.

Even more on the upside is that tightening emissions standards are becoming a global trend. Stricter requirements are not only being implemented in developed nations but also in places such as Brazil, South Africa and China. Compliance will require the use of platinum group metals (PGMs), meaning there is likely to be palladium used where it hasn't been used before and more palladium used in vehicles whose emission systems already contain the metal.

Supply, demand and an undervalued metal

Beyond the amount consumed for auto catalysts, there remains about 40 percent of the annual palladium supply. A number of the industrial purposes for which it is used, such as chemicals, electrical products, and pollution control devices for non-road engines saw growth last year and the prospects going forward are also positive.

However, the picture for supply is not as bright as that for demand. Consumption of palladium has long exceeded the amount that is mined annually. The gap has been filled by recycling and sales from Russian stockpiles of unknown size. Market watchers have been predicting that these sources cannot continue to adequately fill this role, especially given the predictions for demand growth, and are expecting deficits in 2012.

Following reports that Russian officials announced figures for future palladium sales, Johnson Matthey said the market response was likely muted because shortfalls have already been priced in.

Current economic uncertainty may force palladium prices lower, but that should not be used as an ultimate indicator of the metal's fate. Instead, when looking at the fundamentals-platinum is a rare metal expected to become scarcer though needed for a purpose for which the only substitutes are more expensive-the current price and any near-term declines may be best viewed as a discount and the ideal opportunity to enter or expand one's position in the market.