Commodities Should Look Interesting to Contrarians

Economic stagnation in the Eurozone, slowing economic growth in China and a robust U.S. dollar has opened a few trading opportunities in our view.

Commodities have suffered thus far in 2H14 and the price of platinum has been hit particularly hard.

The weakness in the precious metal is two-fold. Platinum is considered a precious metal with a major industrial usage, namely for emission control in catalytic converters.

As the strength of the U.S. economy continues to grind upwards (at least compared to other mature economies) the likelihood of an ever increasingly hawkish Federal Reserve stopping its quantitative easing policy and actually setting up for higher interest rates becomes much more realistic of late.

This will hurt the precious metals space decreasing its demand as a “storage of value” material. Gold, silver, platinum and to a lesser extent palladium have seen dramatic price declines as a result.

Platinum in industrial usage faces challenges from a slowing global auto market. U.S. auto sales, with the exception of Chrysler perhaps have been impressive but less than expectations. Vehicle sale abroad have been just as lackluster.

Europe in particular has an impact on platinum as the metal is used heavily for diesel emission control and Europe is a big buyer of the metal for these purposes. Eurozone manufacturing, according to Markit Economics has come to a halt with their Eurozone Manufacturing PMI index falling to a 14-month low of 50.3. Any figure greater than 50 signals manufacturing expansion.

More specifically, Europe’s largest economy, Germany saw its PMI reading dip below the 50 level. Industrial production in Germany dropped 4% from July to August, coming in way below expectations and was the largest month-to-month drop in five years. German factory orders fell 5.7% between July and August, again showing the largest single month drop in over five years.

In our opinion, this places greater pressure on Mario Draghi and the folks at the ECB to open the monetary spigots even further as the threats of an economic slowdown and deflationary cycle become ever more evident in the region.

Platinum prospects

Given the tale of doom surrounding platinum, as a contrarian investor one needs to consider the prospect of an investment in the metal. For one, demand for the metal (especially in the automotive arena) exceeds global supply.

Figure one shows total global supply and total global net demand for platinum. These figures are provided by Johnson Matthey as shows a global deficit for the metal in 2012 and 2013. Barclays estimates that there will continue to be a global deficit for 2014 and 2015 to the tune of 1.8 million and 433,000 ounces, respectively. The large deficit for 2014 was largely related to the South African mining strikes that took an estimated 1 million ounces off the market.

Looking at figure two, the supply / demand scenario should work well for the price of platinum over the next six to twelve months.

There are other factors in play such as unproductive or inefficient mines reducing or stopping production due to pricing pressures.

Impala Platinum Holdings Ltd., owners of the largest platinum mine in Johannesburg are seeing yields on their bonds reach record levels as investors speculate the company will need to go out to the capital markets and raise money for platinum production.

Any crimp in supply will surely have a positive effect on platinum prices.

Representatives from Russia and South Africa are meeting to discuss cooperation in support of platinum prices.

The two countries represent approximately 80% of platinum group reserves, and while we are not in support of an OPEC-style platinum group pricing structure, the news of a coming arrangement should offer a “floor” on Platinum, Palladium and Rhodium.

Given the scenario playing out, we are taking a position in the following:

BWX: SPDR Barclays Capital International Treasury Bond ETF $57.50

FXE: Currency Shares Euro Trust $124.40

SLV: iShares Silver Trust $16.40

PPLT: ETFS Physical Platinum $121.45

Covered option writing against these positions are warranted for those that are optionable.

- Joseph S. Kalinowski, CFA