The Ultimate Guide To PALL (Palladium ETF)

by on January 9, 2010 | Updated January 12, 2010

As the ETF industry has expanded in recent years, a significant portion of growth has come from the tremendous rise in popularity of exchange-traded commodity products. In addition to broad-based funds such as DBC or DJCI, several commodity-specific products have accumulated billions of dollars in assets, and several were even among the very largest of all ETFs at the end of 2009. Among commodities, precious metals have been particularly popular, swelling in size in recent years as investors looked to add non-correlated assets and protect portfolios from the ravages of inflation. The SPDR Gold Trust (GLD) has a market capitalization of more than $40 billion, while assets in the iShares Silver Trust (SLV) exceed $5 billion.

But the opportunities for precious metals investing go far beyond these “super funds.” The universe of precious metals ETFs continues to expand, as evidenced by the recent launch of the first palladium ETF from London-based ETF Securities, the ETFS Physical Palladium Shares (PALL). Palladium presents a unique set of risk and return characteristics, and as shown by the intense speculation leading up to the launch, could prove to be very popular among U.S. investors.

Long Road To Market

European investors have had access to a palladium ETF for years, but PALL’s road to market was a challenging one. Because global supplies of palladium are so small — annual production is about 8 million ounces — many worried that the launch of an ETF could result in “hoarding” by investors and distort prices paid by industrial users of the metal. In December 2009, the SEC ultimately approved a rules change that paved the way for the launch of a palladium ETF. Shortly thereafter, Susquehanna seeded the fund, agreeing to purchase 100,000 shares. PALL launched in early January 2009.

Palladium 101

Unlike gold and silver, palladium wasn’t discovered until the 19th century, when an English chemist named the metal after a Greek goddess. Palladium is one of the six platinum group metals (PGMs), a collection of elements with unique chemical properties used in a wide variety of products.

Palladium has a number of industrial uses — it is found in computers, mobile phones, and LCD televisions — but more than half of global supply goes into the manufacture of catalytic converters, a key component of exhaust systems for automobiles. As such, demand for palladium is generally correlated to the health of the global auto industry.

Russia is the world’s largest producer of palladium, but its contribution to total supplies has declined significantly over the last decade. In 1999, Russia mined 5.4 million ounces of palladium, or 65% of the global total. By 2008, production had slipped to 3.7 million ounces, or less than 45% of world supplies. In addition Russia, South Africa, Canada, and the U.S. are the biggest palladium-producing countries.

As prices of PGMs soared in recent years, recovery of these metals from old automobiles has become an increasingly common activity. Supply from this activity increased from only 195,000 ounces in 1999 to more than 1.1 million ounces in 2008 and is expected to rise further, particularly following the Cash For Clunkers plan implemented in the U.S. in 2009.

Palladium Supply and Demand

Palladium Price Drivers

After rising above $1,000 per ounce in 2001, palladium prices declined for the next two years, falling below $200. As of January 2009, palladium was trading at about $430. Because palladium is used in various industrial applications and has appeal as an inflation hedge, prices for the metal can be impacted by a wide variety of factors.

Price drivers of palladium include:

  • Production levels in South Africa, Russia, and the U.S.
  • Hedging activity and unwinding by palladium producers and consumers
  • Inflation expectations among investors
  • Geopolitical tensions in palladium-producing regions

While the manufacturing sector accounts for the vast majority of platinum demand, the metal is also becoming popular as an investment. Physically-backed investment demand, including coins, bars, investments held in allocated accounts and exchange traded products, has steadily risen over the last decade and represented approximately 5% of total reported demand in 2008.

ETFdb Pro members can read more about the drivers of precious metals ETFs in the ETFdb Category Report (if you’re not a Pro member yet, sign up for a free trial or read more here).

Getting Physical

Prior to the launch of PALL, there were several existing exchange-traded products offering exposure to PGMs (although none focusing on palladium), including the iPath Dow Jones-UBS Platinum Subindex Total Return ETN (PGM) and UBS E-TRACS CMCI Long Platinum Total Return ETN (PTM). Another UBS product, the CMCI Short Platinum (PTD) offers short exposure to platinum.

PALL is different from these products in a few very important ways (beyond focusing on a different metal altogether). First, PGM and PTM are structured as exchange-traded notes (ETNs), meaning that they expose investors to some degree of credit risk. ETNs are essentially senior, unsubordinated debt instruments backed by the issuing financial institution. While this structure can reduce tracking error, it also creates potential, however unlikely, for losses stemming from a default.

PALL is a physically-backed ETF, meaning that it buys and stores palladium in secure vaults. PGM and PTM, on the other hand, are linked to indexes that employ futures-based strategies, reflecting the returns that are available through an investment in futures contracts on platinum. While changes in spot prices generally correlate to changes in futures prices, the relationship is far from perfect. There are a number of nuances to futures investing, meaning that increases or decreases in spot prices are only one of several factors that impact the prices of PGM and PTM. Contango in futures markets can eat into returns on commodity products, as investors in UNG and USO learned the hard way in 2009. But the results aren’t always unfavorable – a futures-based strategy to outperform in certain environments.

The underlying assets of PALL consist of palladium bullion, and the objective of the fund is to reflect the performance of the price of palladium (meaning that it should track the spot price of the metal very closely). The metal entitlement of each share of PALL is 0.1 ounces of palladium.

Variety Of Uses

The possible uses for palladium in a portfolio are numerous. As a precious metal, PALL could potentially provide protection against inflation or act as a safe haven investment in uncertain economic environments. Its prevalence in automobiles also makes this fund a way to bet on a sustained recovery in the global automotive industry.

PALL has already proven to be a big hit with investors, and the fund will likely gather considerable assets in coming months. For updates on this fund’s performance, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.