The Controversy Over Palladium and Platinum ETFs

by on April 23, 2009 | Updated May 14, 2009 | ETFs Mentioned:

Precious metal ETF issuances such as GLD have been warmly welcomed by investors and traders, after some (barely remembered) initial apprehension. And palladium and platinum-backed ETFs are already trading on the London exchange. So why all the controversy over the possibility of a platinum ETF and palladium ETF in the US?

It turns out, the worldwide market for these two metals is–relative to the market for gold or silver–pretty small. So an ETF backed by bullion of the metals would be, if it got a lot of asset inflows, in effect “hoarding” them. The buying spree of the two metals by their respective ETFs could have a drastic effect on the commodity price for industrial players.

And it may surprise you who the worriers are: not the platinum buyers, but the producers! Here’s a quote from a recent IndexUniverse article on the subject:

There were concerns that the market for platinum was too thin, and that hoarding by the ETF would create a shortage in the physical metal, which is used in everything from catalytic converters to jewelry.

At least one platinum mining firm came out against the concept, worrying that hoarding would drive up prices in the short term and hurt long-term industrial demand. With commodity prices (and demand for platinum and palladium) down however, those worries appear to have gone away.

So who would really get hurt if there was an upward swing in platinum and palladium prices?

The Demand for Platinum and Palladium

Both platinum and palladium are mainly industrial metals. Yes, platinum is a popular choice for modern engagement rings, but it is also used in the manufacturing of catalytic converters in the automobile industry. This product alone accounts for 55% of platinum’s demand, according to this Hard Assets Investor article on SeekingAlpha.

Of course, with auto production–and thus catalytic converter production–plummeting as of late, there isn’t as much protest against the idea of new platinum buyers lately. (The auto industry is worrying about other more pressing problems for the moment.) Meanwhile, platinum and palladium prices plummeted in 2008 due to oversupply, which probably made the mining firms more willing to cash in on a short term price increase (due to ETFs buying bullion), even if it has a negative effect on the long-term industrial use of the metals as manufacturers explore alternatives.

Quick, While No One’s Watching

With the auto industry in a state of confusion and distress, and with palladium and platinum prices figuring to stay volatile for the near future, there’s a short window for an issuer to get into the market without facing as much protest as they otherwise would. Which is exactly what London-based ETF Securities (ETFS) is trying to do. On April 2, they filed with the SEC to issue the first bullion-backed platinum and palladium ETFs to the U.S.

Of course, the ETFs may or may not be approved, and even if they are approved, it might not be smooth sailing. If equities continue to slowly recover, the love affair with commodities may end, and it may be hard for new precious metal ETFs to get asset inflows. Price volatility could temper investor interest. And less demand from auto manufacturers could make for an extended bear market for the metals. Like all new ETF issuances, it’s anyone’s guess how successful they could be.

Further Reading on Palladium and Platinum ETFs

If you’re interested in more information on the issue, I recommend the following articles: