The Gold Report: Erica, the June 6 issue of CPM Precious Metals Advisory reported that, "Some investors view the present easy monetary policy of the U.S. Federal Reserve as a great reason to purchase gold, seeing the current monetary policy as likely to result in higher inflation and the dollar losing value. When viewed over the longer term, much to the contrary has happened since the Fed began to ease monetary policy." It seems like the returns for quantitative easing (QE) are indeed diminishing. Tell our readers what you mean.
Erica Rannestad: We ran an analysis on the impact of QE in the U.S. on gold prices in our recent report. We found that the percentage return during the periods of QE1 and QE2 were positive, but that QE2 is lower in percentage and dollar terms than the increase during QE1. The reason for that is investors were buying gold as a safe-haven asset during those periods. These quantitative easing measures have not translated to higher inflation that has trickled down to raise gold prices. It also has not contributed to a weakening of the U.S. dollar, which would also be positive for gold prices. Rather, during the period since monetary easing began in 2007, the dollar actually held up pretty well.
TGR: Indeed it has. Let's look at the performance of gold in QE1 and QE2 in more specific terms. The price of gold rose about 36% during QE1 and about 12% during QE2. If there is a QE3, could there be a price increase of around 4%, which would be consistent with the pattern established in the first two rounds of QE?
ER: There are plenty of reasons to continue to buy gold and more reasons to just hold gold positions, but we don't think that QE3 would spur a 4% increase in the gold price. We believe that the returns are diminishing, but it's not associated with the introduction of additional QE.
TGR: How have the prices of precious metals like platinum and palladium reacted to QE measures?
ER: They haven't reacted to QE measures, necessarily. When the Federal Reserve first began reducing its target rate, platinum and palladium prices were falling because of the financial crisis. There was a contraction of the global economy that resulted in a decline in demand for the various end products that platinum and palladium are used in.
About 40% of platinum fabrication demand comes from the auto sector and 25% comes from jewelry. About 60% of palladium use comes from the auto sector. Jewelry is actually a very small portion of palladium demand. The larger component would be electronics, which is about 15–20% of demand.
"Any asset that boasts PGM byproducts is definitely at an advantage because they're high-value metals. It's a nice little revenue stream."
TGR: Where does investment demand factor into the economic picture for those metals?
ER: There has been tremendous weakness in investment demand this year. There's been a decline in platinum exchange-traded product holdings. The holdings backing those products are down about 6% since March.
There's also been a massive buildup of short positions in the NYMEX platinum futures and options market since March. They're at record levels. Gross short positions are approaching 900,000 oz (900 Koz). We've started to see an increase in long positions recently, but the gross short positions have remained elevated. There could be some upward pressure on prices once the aggregated gross short position is reduced. Until that happens, the price remains under pressure.
The investment picture has been building on the negative view of fabrication demand: slower growth in jewelry demand in China and weakness in the European economy that has been weighing on the auto market. Investment demand is weak because of those pockets of weak fabrication demand. There could be an improvement in prices a little bit later in the year.
TGR: Why is South Africa receiving unusually negative attention regarding its platinum group metals (PGM) projects and mines?
ER: There are a host of issues being faced by PGM miners that are difficult to control because they're mostly external in nature. The entire industry is struggling to attract positive attention because it's been demonstrating higher costs and lower production levels.
The biggest contributor would be production disruptions, which increase costs and reduce revenues at the same time. Those production disruptions are mostly caused by labor strikes, which take a toll on supply. Safety stoppages are another reason. Since the fourth quarter of 2011, there's been an uptick in safety stoppages issued by the Department of Mineral Resources.
There are also disruptions due to geological complexities. PGM mining is typically very deep level underground mining. The miners typically face issues such as faulting that make it difficult to extract ore from deep level mines.
TGR: These operations are very different from most North American mines in that they make up for their lack of machinery and automation with thousands of workers.
ER: PGM mining has to be labor intensive because of the nature of PGM mineralization. There really is no way of avoiding the labor-intensive method for extracting PGMs without compromising recovery rates. It is more labor intensive and it has to be.
TGR: On the flip side, are the rising prices of these metals due to the supply constraints created by these problems?
ER: Yes and no. These metals are so industrial in nature that the prices tend to swing more closely with developments in demand trends. The picture for supply since the fourth quarter of last year has been deteriorating, but it hasn't translated to higher prices because of the role that demand is playing right now.
That said, the higher costs of mining are expected to result in some shuttering of operations. We saw that recently with Aquarius Platinum Ltd.'s (AX:ASX; AQP:LSE; AQP:JSE) joint venture (JV) Marikana mine, which just closed a few days ago due to low PGM costs and high production costs.
TGR: What was its cash cost per ounce?
ER: In 2011, its C1 PGM cash cost was about $994.90/oz. It was the second highest cost mine. It improved its cash costs over the past few years, but the deteriorating operating conditions in South Africa in recent months likely weighed very heavily on the mine's operating performance.
TGR: A dirty little rumor that's been making the rounds is that South Africa will nationalize at least a portion of its PGM mines given its stranglehold on global supply. Do you give any credence to those whispers and rumors?
ER: There's always talk about nationalization of the mining industry in South Africa. I don't think it's going to happen, but only time will tell.
TGR: Only one PGM mine is scheduled to open in 2012 and that's First Quantum Minerals Ltd.'s (FM:TSX; FQM:LSE) Kevitsa mine in Finland, a relatively small operation. What are some mines that are scheduled to enter production in 2013 and beyond? Will those mines produce enough PGMs to affect prices?
ER: The Kevitsa mine is going to produce PGMs in a concentrate as a byproduct of nickel. It will only have a marginal impact on supply.
In 2013, Colossus Minerals Inc. (CSI:TSX; COLUF:OTCQX) could put into production its Serra Pelada project in Brazil. It's primarily a gold project, but it would actually become the first mine in Brazil to produce PGMs since the 1800s.
The company has only developed a resource of about 700 Koz of PGMs. Its drill results have suggested that the asset is pretty high grade. It plans on producing the PGMs in concentrate and then selling that to smelters. It's coming out with an NI 43-101 resource statement and it expects to produce at some point. It will be an interesting new play in Latin America because there's only a little bit of PGM production in that region.
TGR: Do you think having a mine in Brazil gives Colossus a distinct advantage?
ER: Not necessarily. Any asset that boasts PGM byproducts is definitely at an advantage because they're high-value metals. It's a nice little revenue stream.
TGR: Are any other companies going into production next year?
ER: Northam Platinum Ltd. (NHM:JSE) could put its Booysendal North project in South Africa into production. It would exploit both the Merensky and the UG2 reefs of the Bushveld Complex, first tapping into the UG2. It's expected to produce 100 Koz of PGMs each year, which would replace the Marikana mine that was just shuttered. Booysendal North has a pretty long mine life of about 50 years.
TGR: That's a total resource of almost 60 million ounces (Moz). Is that all platinum group metals or mostly platinum?
ER: It's PGMs and gold, but it's likely more platinum. It is tapping into the UG2 quite a bit and the UG2 has a more highly concentrated palladium content. It also has chromite as another revenue stream.
Northam Platinum is interesting because it tends to lean more toward technological innovations. It's done a lot with deep level mining. It operates the Zondereinde mine, which is the deepest level mine in the Bushveld Complex. It was able to develop a method of mining that used water to naturally cool down temperatures so it had less dependence on refrigeration. It's introducing a reverse decline to transfer ore from the mine to the concentrator plant at the Booysendal project to reduce costs. It's always doing these kinds of interesting new techniques.
TGR: It only plans to produce roughly 127 Koz/year, but it's got 60 Moz. It could certainly ramp up production fairly easily. Why wouldn't Northam want to produce more metals annually?
ER: I think it is probably taking it in phases. It may be producing that much to produce revenue as soon as possible and then it will build out from there. Additionally, it would need to upgrade these resources to the reserve category in order to build a mine plan for higher annual production.
TGR: There are a couple of operations planning to go into production in 2014. Tell us about those.
ER: The largest project coming onstream is Platinum Group Metals Ltd.'s (PTM:TSX; PLG:NYSE.A) Western Bushveld JV project in South Africa. It could produce around 250 Koz/year. This could increase when the company is able to ramp up project three of the Western Bushveld JV.
It has about 8 Moz in resources there. Once it starts development, it will likely want to increase the resource estimate, transfer some of the resources into reserves and build that up. There's potential upside there.
TGR: Is it on schedule with the development of Western Bushveld JV so far?
ER: Yes, it has been actively developing it. It has been reporting over the past few months that it will be in production on time and on budget. More often than not, however, these things come onstream later than projected. Because it's kind of close to the start date, there's less uncertainty there.
TGR: There are 20 projects on the chalkboard after 2016. It's quite likely that those all won't be developed. Could it negatively affect price if so many mines come into production?
ER: The likelihood is that those projects would come onstream between 2016 and 2025, or not at all. Some of those projects are really complicated or require a lot of infrastructure to be built up, which involves the state and permits, among other requirements. A lot of these projects will take much longer to put into production.
It's a positive indicator if a company comes up with a really interesting or positive funding deal. For example, recently Stillwater Mining Company (SWC:NYSE) engaged in an agreement with Mitsubishi Corporation on its Marathon asset in Canada. That agreement gives Mitsubishi 25% ownership of the asset and an option to purchase 100% of the PGM production from Marathon.
Deals like that show strong funding for development. It's much more likely the asset will be developed more actively and that the development will be accelerated. Companies that have trouble getting funding for projects are going to take much longer to get into production.
TGR: Stillwater is one of the few PGM producers in North America.
ER: The Stillwater mines and the Lac des Iles mine owned by North American Palladium Ltd. (PDL:TSX; PAL:NYSE) are the only primary palladium mines in North America and the world. Marathon would be the third primary palladium mine in the world.
TGR: What advice would you offer to investors looking to gain some exposure to companies mining PGMs?
ER: Investors should buy PGMs when they're very bullish on the economy. That said, there are regional differences in economic conditions that can cause an investor to be more bullish or bearish on platinum or palladium.
For instance, if the European auto market isn't doing well then they'd likely be more bearish on platinum. That's the case right now. Palladium is a bit more volatile, but it tracks economic conditions more closely than platinum does.
Platinum can behave more like gold or silver as an investment asset. It's a little less volatile. It can behave more like a hedge against inflation or a safe haven. If an investor wants a little bit more exposure to safe-haven qualities, platinum would be a better play.
There is also more investor interest in developing projects that could produce PGMs in countries other than South Africa. There are a lot of projects being developed in Canada and some in Minnesota in the United States. Those are a good way to reduce exposure to the risks of cost increases and production disruptions in South Africa. However, South Africa has the highest PGM basket price because there's a higher platinum content. That gives investors more exposure to potentially better revenues. Investors have to pick and choose.
"There is also more investor interest in developing projects that could produce PGMs in countries other than South Africa. There are a lot of projects being developed in Canada and some in Minnesota in the U.S."
TGR: We've talked about platinum and palladium, but we haven't talked about rhodium. There's been quite a bit of price volatility in rhodium over the last year. Is that a good play for investors right now?
ER: Poor rhodium. It's less than half the price that it was the beginning of 2011 because of deterioration in demand. A couple of years back, rhodium reached $10,000/oz. When that happened, users were saying, "We've got to stop using rhodium!" There was a lot of thrifting. For instance, there have been some technological advances in the auto industry that have helped reduce rhodium use for auto catalysts. Rhodium is competing with that technology.
There's also been an interesting trend development in rhodium supply. Rhodium supply in South Africa has grown at a much faster pace relative to platinum/palladium in the past 20 years. A lot of that is because of new developments in the processing of the metal and greater recovery rates of rhodium. There have been larger surpluses of rhodium in the past decade. That coupled with aggressive developments toward substituting and thrifting in auto catalysts and other catalytic applications is bearish for rhodium. Rhodium is a good medium- to long-term play, but I expect some further declines in the price in the short term.
TGR: I'm sure Cecil Rhodes is turning in his grave.
CPM Group's PGM Yearbook will be released June 26. Readers can purchase it at a discount price on the CPM Group's website. CPM Group analysts will present the main conclusions of the Yearbook at 10am on June 26. To register for this event, click here.
Erica Rannestad is a commodity analyst at CPM Group. Rannestad covers the precious metals and agricultural softs markets as well as currency markets. She is responsible for building CPM Group's supply and demand statistics for the precious metals Yearbooks and Long Term Outlook reports. Rannestad is currently most closely monitoring the silver and platinum markets, providing near- and medium-term price forecasts for these metals in CPM Group's Precious Metals Advisory, a monthly publication. Rannestad also often contributes to and supports CPM Group consulting projects and regularly presents CPM Group's market views at conferences and seminars around the world. Rannestad holds a Bachelor of Science degree in finance from Fordham University's Gabelli School of Business.
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Disclosure:
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Colossus Minerals Inc. and Platinum Group Metals Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Erica Rannestad: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.
