South African Politics and Platinum and Palladium Prices

09 February 2018

To bastardise Hemingway, Jacob Zuma’s political demise appears to have come about “slowly, then all at once”. Years of the ANC governing as the party of liberation, and then the party of failed promise tainted with corruption and little to offer the South African in the street, have forced change at the top.

Given South Africa’s dominance of world platinum supplies, mining an estimated 4.38 million Tozs in 2017, or around 70 pct of world mine supply, how do we think that these political developments will affect platinum and palladium and are there other factors that compete with the South African situation that need to be considered?

Politics

Firstly, Jacob Zuma’s replacement, Cyril Ramaphosa, is a seasoned political operator, elected president of the ANC party last December, albeit on the narrowest – 51 pct. – of majorities. He has long been seen as the man to rescue the ANC and to some extent South Africa from the incompetence of the preceding ANC leadership. Initial reactions should therefore be positive, and certainly the reaction of the South African Rand (the ZAR) in the period starting just prior to the ANC party elections appear to endorse that view, with the ZAR strengthening from about 14 to just over 12 Rand to the US Dollar from late November to early January.

The reality is that the ANC leadership is still largely controlled by governors of the most important states in the country, such as David Mabuza and Ace Magashule, who are not necessarily aligned with reform programs, and cleaning the Augean stables would take even the most capable politician considerable time. And while Ramaphosa is the union hero from the 1980’s and Nelson Mandela’s’ right hand during the 1990s, he is a long way from the man of the people that he was. In so many words, ‘beware euphoria’.

Impact of local currency movements

As the ZAR has strengthened, platinum in US Dollar terms has also strengthened, as dealers believe that weaker receipts in ZAR terms for South African platinum miners must be compensated for by a stronger price in USD. So far, that has gone according to plan.

Additionally, the price was rallied from the lower bound, which appears to lie around the US$800-850 level. This ZAR-based impact on the price is probably the single easiest effect to identify in connection with changes in the South African political scene.

This has not been a significant factor in palladium prices, which have been driven by concerns over a supply deficit worldwide.

Production

After a slight contraction in 2016, SA PGM production increased in 2017, and there is no obvious reason why production in 2018 should be materially different, barring accidents and smelter outages. PGM producers have been through a process of de-stocking in recent years, and that begs the question of how much stock remains to reach the market when production hits a snag.

Sibanye Gold’s takeover of Lonmin (still awaiting shareholder approval, although recommended by the Lonmin board) should have a net positive effect on supply, judging by Sibanye’s strong record on delivering cost-effective mining elsewhere.

Politics shouldn’t have a big impact, although there are questions over Cyril Ramaphosa’s connections in the Marikana incident in 2014, and whether that could translate into worker militancy at some point in the future. The consensus is that industrial action by platinum mine-workers in the past has run down household savings and that this has so far deterred aggressive strike action subsequently, plus stock-building by producers has meant that producers have managed to have something to sell despite interruptions to production.

Demand

Total platinum demand, which was estimated at 7.60 million for 2017, down by 621,000 Tozs from 2016, remains constrained by concerns over Diesel, and future developments in the alternative fuel sector, and a weakening Chinese jewellery sector.

Total demand in the EU, the principal market for Diesel-engine passenger cars, was up 3.40 pct. year-on-year in 2017 basis registrations, but December was down 4.90 pct. compared with December 2016. Demand in Europe is expected to moderate in 2018 for two reasons. Firstly, Diesel engine car demand is expected to weaken slightly within the total demand for passenger vehicles, and secondly, new emissions regulations with tougher ‘real world’ thresholds are expected to lead to an uptake of SCR (‘Selective Catalytic Reduction’) which uses less or no platinum and injects urea into the exhaust stream to tackle NOx (Nitrous Oxide) emissions. NOx is now a key focus for emissions regulation.

Alternative fuel vehicles saw an increase in registrations of 39.70 pct. in 2017, with 55 pct. of growth coming from ‘Hybrid Electric Vehicles’, meaning that there is still an internal combustion engine in the drive chain, however, one that is more than likely to be a gasoline unit. Total Alternative Fuel vehicles sold in the EU amounted to 853,000 units last year.

In the US, total annualized car sales declined slightly last year from 18.05 million units to 17.76 million units, and annualised sales in January suggests further weakness. Recent tax cuts may feed through into more demand on the margin, however US auto sales peaked at 17.90, 17.62 and 17.67 million units a year in 1999, 2002 and 2004 respectively, however as always, remember that the United States is a gasoline market and platinum-based catalysts are correspondingly less in demand.

In China, auto demand is expected to remain healthy in 2018. Right now, China is looking good – despite efforts by observers to crow-bar it into a ‘Japan circa late 1980-something’ paradigm.

In Chinese jewellery demand there are reports of an uptick in gold demand which is positively associated with jewellery demand for platinum so a market which has been shrinking for the last couple of years may turn around and grow.

Supply factors beyond South African mine production

Scrap recovery is a major feature of platinum fundamentals, and all other things being equal this year should see more supply coming to the market as vehicles with high platinum loadings and European Diesels reach the end of their lives. Previously such scrap had been hoarded with lower prices for PGMs and for scrap steel dis-incentivising scrap recycling. However, steel scrap prices have rebounded since 2016, with prices now up to US$360-370 per tonne, compared with US$210-250 two years ago¹. The World Steel Association assumes global steel demand will grow by 3 pct. in 2018, which ‘ought’ to keep prices steady for prospective scrappers.

1 (Basis European Steel Ferrous Scrap 1^st month price index & US bushelling generic front month.)

Investment

Platinum

Platinum has seen a substantial inflow of buying, using the CME futures contract as a the benchmark futures investment. Managed money has bought 1.642 million Tozs of platinum since the 24^th of October, when net positioning stood at minus 108,350 Tozs. Since that data point, shorts who speculate against the price have bought back 0.606 million Tozs, and Managed Money longs have added 1.0357 million Tozs.

What is disguised in these figures is that December 2017 saw the most bearish bets against platinum placed since Managed Money was split out as a reportable sector by the American CFTC (Commodity Futures Trading Commission), with short bets against platinum hitting an all-time high’ of almost exactly 1.80 million Tozs. Buying from short-covering between the 19^th of December and the last data point, the 30^th of January, reached 1.117 million Tozs, equivalent to almost two months of annual total demand from all sources. Meanwhile longs have built up another million Tozs since early November, when prices were in the low 900s.

With net positioning now at the same level as seen in February of last year, it is probably fair to conclude that all of the good news from futures buying is in the price, and that there isn’t a huge amount to expect from this quarter.

What about buying from ETFs? There hasn’t been a big shift in global ETF holdings. They have grown by around 80,000 Tozs since late October and at around 2.50 million Tozs, stand at about 87 pct. of the all-time high back in August 2015.

Palladium

Managed Money futures have remained die-hard longs for months, building to a recent peak of 2.89 million Tozs on the 9^th of January. Managed Money shorts have maintained negligible positions of around 0.110-0.160 million Tozs for several months now.

Palladium ETFs have declined markedly, from almost 1.60 million Tozs to 1.23 million Tozs, not surprisingly, partly because profit taking but also because when the futures market is in a backwardation, it makes sense to be long futures rather than a physically-backed ETF, as the roll from one month to the next increases your total returns.

Technical Analysis of price movements - platinum

Platinum in USD has rallied up to technical resistance at the Weekly Ichimoku cloud, and has rolled down the resistance line faithfully. Platinum continues to range trade between US$890-1050, and this may encourage more selling from profitable longs or shorts looking to exploit the expected range.

Using Hourly point and Figure, the trend is bullish, but price targets extend back to US$930 and US$875.

The Forward market in platinum

The platinum forward price curve remains in contango, and has barely altered in the last few weeks, apart from a hint of tightening in the 12 month rate. This is consistent with the idea that platinum remains in a fundamental surplus, and that the news out of South Africa has yet to change market views on liquidity.

The Forward market in palladium

Palladium forwards remain in a reasonable backwardation, consistent with palladium being in deficit.

Summary

The South African political situation is certainly interesting, and hopefully changes can be implemented without disruption or violence. The departure of Jacob Zuma can only be seen as an unalloyed good, however his leadership has corroded South African institutions for long enough that it will take time to restore them. The likely impact on the platinum price may be relatively muted, notwithstanding affects driven by the changing value of the ZAR.

If investors lose confidence in the ability of Ramaphosa to effect change, the ZAR would be likely to weaken again, which all other things remaining equal, would have the paradoxical effect of lowering the USD platinum price when the situation in South Africa would appear to worsen.

Zimbabwe, a political and economic disaster less than two hours flight from Johannesburg – so very much a geographical peer – provides a good example of why observers should be optimistic about the South African platinum industry at a time of change. Local production has grown for every year from 1996 to 2016, a track record that Johnson Matthey described in May of last year as “unparalleled in the platinum mining industry”. Given the huge headwinds for investment and production created by Robert Mugabe and his cronies there, that is an achievement and shows what can be done under far worse conditions.

The price of platinum is still buffeted by technological and regulatory change in emissions control and patterns of consumption in China and elsewhere that loom larger than changes in the composition of the ANC leadership, however the change in leadership will be reflected in heightened expectations of change for the poor and disaffected among South Africa’s mineworkers, and if hopes are not met, there is always the risk of disruption to supply.

Managed Money Long and short positions (bars) with line chart showing net positioning