Substitution still missing in Macedonia

September’s Macedonian trade data is out, important for PGM market participants as it is the best way I can come up with to track whether super-expensive palladium is being substituted out of the diesel catalysts for cheaper platinum 1.

So far there has been no evidence of such substitution, indeed the palladium ratio of the two metals has actually trended higher through most of this year.

September was a little different. Imports of both metals plunged, but because palladium fell more sharply, the implied ratio did move in platinum’s favour, to 36% by weight, compared to 44% in August’s data.

Source: UN comtrade, Matthew Turner, November 2019

But it’s way too soon to read anything into this. 36% is actually the six-month average, and higher than seen in many months this year.

The sharp fall in imports of both metals is quite interesting. It seems unlikely there is going to be sharp fall in output so one suggestion that comes to mind is metal was being stockpiled ahead of potentially disruptive “no-deal” Brexit (the metal comes from the UK), though that is guesswork.

What is clear is the imported price of palladium is rising fast. In September it was $1,570/oz, the highest on record. That corresponds to the market price in the first part of the month – October’s was much higher.

Notes:

  1. For details of why this is the case, which in short because Macedonia’s main importer is a huge JM catalyst factory, see here

The gold S&D

The World Gold Council released its 3Q demand and supply statistics today (from research group Metals Focus). The summary page does a good job in explaining their key findings.

One thing I always look out for is the S&D balance, and in particular the surplus/deficit. From late 2016 the gold market entered a period of very large surpluses – totalling 361t in 2016, 336t in 2017 and 229t in 2018.

It is not clear what this was. It was not ETF demand as that is included separately. It might be what it once would have been called – “western implied investment”. But it no longer correlated to Comex positions. More likely it was to do with China, which had imported more gold than it has apparently consumed in other forms. Whether it was investment, e..g by HNW individuals, or something else, perhaps leased gold, is still unknown. But it didn’t seem particularly bullish – in fact it felt more like a classic price-weighing surplus.

Towards the end of last year the surplus began to fall. The first chart shows both the quarterly surplus, in light blue, and the rolling 12m average, both in tonnes. A big quarterly deficit in 4Q 2018 reduced the average sharply and so far this year though it has totalled 217t, that is down from 300t in the first three quarters of 2018.

So should we be concerned that the defiict in the most recent quarter, 3Q 2019 was higher than 3Q 2017 (95t to 57t)? Probably not. After all the gold price has been strong, and as such the surplus seems more likely to reflect unidentified investment. As I noted before deficits can be bearish – the corollary is surpluses can be bullish.

That said, the 2nd chart, which shows the QoQ change in the gold price (edit – note this is logged change) v the surplus-deficit shows little clear relationship either way (though gold’s largest price fall, in 2Q 2013, did match up to its largest deficit).

A similar analysis can be done for the other line items in the S&D balance. Starting with supply, as might be expected there is no relationship between changes in the gold price and the level of mine production 1. But there is a stronger one between changes in the gold price and the level of scrap generation 2 .

On the demand side jewellery is very interesting, with a strong negative relationship. That is in a quarter when the gold price falls a lot, jewellery demand is high, and in a quarter when the gold price rises a lot jewellery demand is weak. The causation here seems obvious, from price to demand, as the other way around makes little sense. 3. To some extent this is driven by 2Q 2013 again, though it would be wrong to exclude this as that was exactly the kind of price-driven buying we are expecting, and anyway the relationship is nearly as good if we do exclude it.

Bar & coin demand surprisingly, shows very little relationship, either in levels (shown in chart) or changes.

Finally we end with two strong correlations. The first is puzzling. Apparently central banks like selling gold in quarters when the price has risen and like buying it when the price is falling. This suggests a certain savviness and speed not usually associated with the official sector, but might be explained by them targeting a fixed $ amount of gold. More research is needed – and indeed more quarters in which central banks are net sellers, with only one datapoint since 2010.

The next is more intuitive. ETF flows are much larger in quarters when the price is rising and lower when it is falling. Are investors trend followers? More likely they are price-setters, with large short-term physical flows driving the price in either direction.

Source: All charts World Gold Council, Gold Demand Trends (data from Metals Focus)

Notes:

  1. If you think it would be stronger against the change in mine production – it’s not
  2. Here though, and elsewhere, there is probably some modelling relationship being captured given the difficulty in directly measuring such flows
  3. Interestingly this correlation is strong, but not stronger, if we use the change in demand

Chinese gold imports remain subdued

China imported 62t of gold in September, according to recently released customs data. This is slightly down on last month, above the lows of summer, but subdued compared to earlier in the year and in 2018.

Source (this and all other charts): China Customs, SGE, Matthew Turner, October 2019

Gold imports in the first nine months of the year have totalled 760t, more than a third lower than the 1,242t seen at the same point of 2018.

Of course one factor is the much higher gold price, with western ETF investors bidding up the price.

But in terms of value of gold imported 2019 is also proving a weaker year than 2018, and even, since the start of summer, with 2017.

Is this something for the bulls to worry about? This Reuters story placed the blame for the very weak summer period on quotas restrictions aimed at restricting the outflow of Yuan. These were apparently eased in August, helping explain why imports have picked up a bit. Presumably at the LBMA conference in Shenzhen more was said about this. Such restrictions do suppress gold demand but if only temporary are unlikely to do lasting damage.

Furthermore there is a real sense, despite all the talk of gold being a 200,000t “stock” market, that if ETF investors are buying a lot of gold, the Chinese can’t have as much. The price rises to see who wants it most. So it’s certainly not as concerning as it looks.

Nevertheless it remains concerning. The biggest risk to the gold market medium-term, in my view, is lacklustre”physical” demand, of which over 50% comes from China and India. In particular it seems to me that gold – both as a consumer good and an investment good – now faces far more competitors (eg smartphones, index-linked bonds) than it once did. Of course some of its qualities are unique and it has a long track-record, suggesting a certain robustness. But it pays to not be complacent.

For the background on how China now publishes gold trade data see my LBMA Alchemist piece from earlier this year.

Still evidence of no palladium substitution

I wrote two weeks ago (“No evidence of substitution away from palladium. Indeed, evidence of no substitution“) that a natural experiment – North Macedonia trade data – could tell us whether high-priced palladium was being replaced by cheaper platinum in diesel autocatalysts.

Answer: it wasn’t and that was a good reason to think the price of palladium could go higher. And indeed it has gone higher, now nearing $1,800/oz.

We now have North Macedonia trade data for August. Does this show any shift towards platinum? Nope. Palladium was 44% of the palladium & platinum imported, higher than the YTD average of 36%. This reinforces the point that 2019 is on course to see palladium’s share rise not fall.

IMF notices precious metals

In today’s latest World Economic Outlook (WEO) the IMF devotes a large-ish section to gold and other precious metals (p.47 onwards here).

Perhaps the most interesting section is on whether they serve as an inflation hedge. Finding a positive but weak correlation to inflation itself, the analysts also look at gold prices against modelled inflation risks. Here they are more positive, saying:

Results of the analysis support the view that precious metal prices react to inflation concerns… An increase in inflation uncertainty by one standard deviation tends, within a month, to raise the price of gold by 0.8 percent and silver by 1.6 percent. A decline in inflation uncertainty can explain half of the observed gold price decline of the 1990s and one-third of the price rise after 2008. The role of inflation uncertainty is, instead, positive but not significant for platinum and palladium, yet irrelevant for copper

For many gold’s main advantage is not inflation but against systemic risk. The IMF also looks at this through reactions to S&P 500 moves. This is something I have long done, and the IMF’s conclusions are the same – gold does act as a safe haven when the S&P 500 falls, silver does but less so, and the other metals do not. Here’s one of my versions of this table.

Finally the IMF also mentions precious metals’ sensitivity to dollar moves. But only to express surprise the beta can sometimes be more than 1 (ie if the dollar falls 1%, gold rises more than 1%). I think this relationship – which is partly obvious given we are quoting the price in dollars – needs more discussion and will do so in a later post.

Deficits can be bearish

In commodity markets it seems widely accepted that market deficits are price bullish and market surpluses price bearish. Intuitively this feels right. A deficit is when demand is higher than supply and inventories (stocks) are falling. Such a situation cannot go on forever, as stocks are not infinite. Ultimately demand has to fall or supply has to rise, and in the absence of other factors (recession, technology etc) the way this happens is via a rising commodity price.

In practice it is not so clear cut, and the easier it is to hoard the commodity, the less clear cut it gets. For metals, and particularly precious metals, where hoarding is not only easy but often desirable, the picture is very muddy indeed.

Take this S&D for Metalium, a made-up industrial metal. In 2019 1,000 units were supplied by mines, 1,200 were demanded by industry. This makes a deficit of 200, or put another way, a fall in stocks of 200. If I asked you what happened to the price in 2019 you would probably assume it moved higher.

Bullish? Bearish?

But what if I then told you that actually what happened was industrial users midway through 2019 saw that 2020 was set to be a very bad year for demand and decided to reduce their stocks by 200?

This now seems bearish! Most likely those 200 units flooded the market, pushed the price lower, boosting industrial demand and reduced mine supply.

In other words whether a deficit is bullish or bearish can depend on the reason stocks are falling.

In base metals, where stocks are mostly held within industry and are relatively stable, this latter scenario might not be that common. But in precious metals it happens all the time, as the stockholders are not industrialists but investors. If in an otherwise balanced market a very large investor decides the future of platinum is bleak and sells their holdings of 1 Moz, the market will be in a 1 Moz deficit but the platinum price will be a lot lower.

So on a static snapshot, market deficits are not necessarily bullish. But maybe we can at least say that they imply a higher future price? After all as we noted at the beginning of this piece, stocks are not infinite. A deficit might reflect a bearish investor throwing in the towel, but they can’t keep throwing in the towel. Ultimately there will come a point when there are no more stocks (or no-one wants to sell their stocks) and the commodity price will have to rise to bring supply and demand back in line.

This is more justifiable, though still not always true. Consider these two scenarios:

  • The industrialists or investors are right in their pessimism, and so a deficit in one year is followed by weaker demand or higher supply in the following year. In this scenario prices don’t have to adjust upwards.
  • The sale of stock is, in itself, new information that changes perceptions. An example would be if a European central bank announced, out of the blue, it had plans to sell gold.

Finally, for gold, where almost all demand is stockbuilding (by investors, but also by people in the form of jewellery) deficits and surpluses are even less well defined. I’ll have more to say about that in another post.

No evidence of substitution away from palladium. Indeed evidence of no substitution

The palladium price has hit a new record high in recent days over $1,700/oz, and the FT has declared there’s more to come unless we see a global recession or substitution of much cheaper platinum. I agree. And yet at present not only is there no evidence of substitution but there’s evidence that there has been no substitution.

It comes from North Macedonia.

This country had little to do with the global PGM markets for much of its history. It is not a producer, and in 2009 reported imports of unwrought PGMs of only $1. That might sound a little implausible, but probably not far from correct – in 2008 PGM imports were less than $20,000.

And yet in 2010 it imported over $100m of PGMs. And by 2018 this was over $1bn, with more than 1 Moz of PGMs imported. This year is approaching $1.5bn.

Source: UN comtrade, Matthew Turner. Note 2019 extrapolated from first 7 months of the year.

What gives? In 2010 refiner Johnson Matthey (JM) opened a diesel autocatalyst plant, which was expanded in 2013. This is why North Macedonia’s exports of catalysts also exploded, rising from nothing in 2008/2009 to nearly $2bn in 2018 (Macedonia has not gone its own car industry).

Source: UN comtrade, Matthew Turner. Note 2019 extrapolated from first 7 months of the year.

This is great for an analyst. Other large catalyst manufacturing countries are also PGM traders, such as the UK, and/or jewellery consumers, such as the China and the USA. This means it is hard to draw firm conclusions from trade data. But in North Macedonia it is just catalysts – therefore it is safe to assume the imported PGMs are being used in that sector.

As such because we can break the trade data out by metal we can use it to estimate what proportions of platinum and palladium JM are putting in their catalysts. If we look at its imports by volume, we see that more platinum is imported than palladium – in 2018 nearly 800 koz of the former to around 350 koz of the latter – making palladium 28% of the combined volume to platinum’s 72%. This is to be expected given the plant is producing diesel catalysts. But importantly this proportion of palladium in the mix doesn’t seem to have fallen in the last few years – indeed it modestly rose from 24% in 2015*.

Source: UN comtrade, Matthew Turner. Note 2019 extrapolated from first 8 months of the year. This chart was corrected on 23-10-2019 as date axis misaligned and so includes August data.

Perhaps the shift has only happened in the last few months? Not that either. Indeed while monthly import data is quite volatile, if there is a clear trend it is the other way, with palladium seeing a share of 50% in one month.

Note: The right-hand chart on 24-10-2019 replaced an earlier one which in error showed palladium relative to platinum, not as a share of all metal.

This data can’t prove no substitution is taking place. There could be other effects masking it, for example if JM have been importing additional palladium than they are using in catalysts (indeed it looks likely), perhaps ahead of the rising price or Brexit. It also might be that the mix of heavy and light vehicle autocatalyst could have changed, affecting the ratio (that’s what seems to have driven palladium’s share down in 2013 after the plant’s first expansion). And if the plant had begun manufacturing gasoline catalysts all bets would be off, though then we would also see rhodium imports, and we have not.

We also can’t assume that JM’s Macedonia plant is representative of all their catalyst plants or those of other catalyst manufacturers. And it is possible substitution is happening in gasoline catalysts, not diesel ones.

Nevertheless it is strong evidence that there has been no substitution. After all most analysts believe if substitution is to come it would come first in diesel, where car and catalyst makers are most comfortable with using platinum.

The palladium price could be going higher yet.

CBGA ends amid a changing world of official sector gold

Today marks the last day of the European central bank gold agreement (CBGA).

Announced on September 27 1999, and renewed at five-year intervals up to 2014, this was often described as a pact to limit central bank gold sales and lending, though arguably its main role was to improve market conditions sufficiently to give space for hefty European sales. From around the mid-2000s European central banks lost interest in selling gold, and as such the pact became rather pointless, the main reason why in 2019 it wasn’t renewed.

Central bank’s attitudes to gold have changed significantly since 1999. Back then global central bank gold holdings still largely reflected the relative economic strengths of countries at the end of Bretton Woods era (1970s). 85% of the world’s 30,300 tonnes of official gold (excluding that held by the IMF & BIS) was owned by the “Advanced Economies”, and almost all of that, 80% of the world, by the USA and Western European countries.

This geographical skew can be seen clearly in the following map, where I’ve resized the countries of the world by their official gold holdings – shows this clearly (ignore the colours)

Central bank gold holdings by country, September 1999 (source: IMF, Matthew Turner)

Fast forward 20 years and a map redrawn to reflect August 2019 gold holdings and at first glance nothing much has changed – the USA and Western Europe still dominate, even if the latter is somewhat smaller.

But look a little more closely and now Russia and Asia are far more visible.

Central bank gold holdings by country as of August 2019 (source: IMF, Matthew Turner)

This is because there has been a slow shift since the first CBGA was signed in 1999. The “Advanced economies” have sold nearly 4,000t, mainly through the CBGA – with gold holdings in the Eurozone down nearly 1,800t, in Switzerland 1,580t, and in the UK over 300t. Their share is now 70%, down from 85% in 1999. But globally gold held by central banks is up around 1,000t – because “Emerging and developing” economies have added nearly 5,000t. Russia and other CIS countries have been at the forefront of this, but China has also increased its reserves dramatically, and so have a reasonably wide range of other countries, including India, Mexico, and Thailand.

This shift is likely to continue. Certainly central banks are still buying, as noted in Tuesday’s post, with 1H 2019 seeing a record amount. This trend has many drivers but a slow – very slow – loss of faith in the US dollar seems behind some of it, not just in Russia. We’ve not seen any evidence of European selling resuming, indeed the main activity there purchases this year and last by Hungary and Poland. However I would think in another 20 years Western European gold holdings will be lower than they are today.

August: central banks keep buying gold but some signs of fatigue

One of the reasons to have been bullish gold over the past 12 months was an apparent step-change in central bank purchases. Not just were traditional buyers such as Russia and China continuing to add to their holdings, but new names were getting involved, including – gasp! – even European central banks.

But after a tremendous 1H, in which net purchases reached nearly 400t, or 65t/month, there does seem to have been a slowdown in recent months. From latest IMF data (and direct central bank publications where necessary) I estimate 22t was purchased in July, and just 16t in August. The YTD total is now 423t.

It is likely these numbers are revised higher. Many countries report late, and given a general bias towards purchases this should mean more to come. In particular Turkey, which has added roughly 9t/month this year, hasn’t yet reported for August. Furthermore central bank gold buying has always been lumpy, for example Poland’s 100t purchase this year mostly in June, and so you do get quiet months.

Nevertheless even those buyers who were buying bought less, with just 11t from Russia and 6t from China in August. Furthermore Uzbekistan has sold quite heavily in recent months. The very high gold price, particular in non US dollar currencies, is perhaps having an effect.

Investment experts – as of 1964

The Golden Eggheads

Fascinating BBC documentary from 1964 about the state of the art in investment advice. It starts off in a gold vault but soon expands to cover technical analysis, Professor RF Kahn (of multiiplier fame), an M&A Boutique and some leading fund managers of the day.

The narrator seems close to saying it is all guesswork at times. How things change.