A look at platinum group metals...
PETER KRAUTH, resource specialist for Money Map Press, considers the precious metals space an overarching requirement for investors. He sees value in every sector, although he admits it takes a contrarian mindset to see the opportunity among stocks that have been trending down for as long as 18 months. In this interview with The Gold Report, Krauth discusses the platinum group metals space, where he expects supply-and-demand tensions will move the price of palladium up.
The Gold Report: Peter, playing equities is all about timing. With many resource equities trading near all-time lows, it seems like a buyer's market. Do you agree?
Peter Krauth: Central banks have been on a fiat money printing binge since 2008. In the last 18 months, that is starting to have the desired effect. The global economy seems to be healing: Demand for goods is coming back strongly, the Dow Jones Industrial Average is setting new records. But at the same time, there will be a serious price to pay with inflation. Commodities tend to benefit from inflation. This is a very good and important space that investors need to include in their portfolios.
TGR: Does that hold true across all commodities?
Peter Krauth: The entire secular commodities bull market is not completely over. It has been going for 12 years, but the average tends to be closer to 17 years. This bull market might last 20 years or even longer, if you consider development in China and India—home to nearly one-third of the world's population—along with the rest of the developing world. These populations are improving their standards of living, growing their incomes and looking for a better lifestyle. That means someone will have to make all the stuff they will want to acquire.
However, there could be a serious low or even a setback in the form of seriously reduced economic demand or an inflationary crisis. That would quiet things for a while, but would also do a lot of cleansing. After that, we will be back on our way.
Nonetheless, investors have to be picky. Every resource has its own cycle. It takes a lot of research to decide where you should be and when.
TGR: What are you telling the readers of your newsletter about increasing their exposure to natural resources in their portfolios?
Peter Krauth: Right now, I see opportunities in base metals, energy and agriculture. And of course, precious metals will remain an overarching requirement to have exposure to commodities.
The larger gold miners have become extremely cheap, with very compelling valuations. As a group, they have not been cheaper since the secular bull market started. Gold may have been in consolidation mode since it reached $1,900/ounce ($1,900/oz) in September 2011, but I believe the secular bull market is far from over, despite the possibility of some sideways or downward price action.
The Market Vectors Gold Miners (GDX), an exchange-traded fund (ETF) that many consider a proxy for the Amex Gold BUGS Index (HUI), has a price-to-earnings ratio (P/E) of 10, far better than the average blue chip stock, which is closer to 16–17 P/E.
TGR: Some say the gold price is like a ball when you drop it. The first bounce is the highest, and the bounces keep getting smaller after each drop. Does that pattern worry you?
Peter Krauth: No. As the consolidation moves forward in time, the price range gets narrower and narrower. At some point, that will have to change. The price will either drop down or break out of its narrowing price range. I believe it will break out.
The gold price is unlikely to stay very stable for an extended period. There is too much political and economic instability. The run on the banks in Cyprus is an example; a lot of Southern Europe has too much unemployment and sovereign debt. Ongoing gold purchases by the central banks provide renewed support for the gold price. All of these factors, and others, will support the gold price, at least in the $1,500/oz range. It could continue sideways for some time, but the bias is very much on the upside.
TGR: What analysis do you do on small- and mid-cap resource names before adding them to your portfolio?
Peter Krauth: My main filters are management, location, cash strength, ease of execution and asset quality. This analysis eliminates many potential plays, but there are more than enough attractive opportunities if you stick to those that stay within those parameters. I see no reason to take on additional risk.
TGR: You recently wrote about the coming global shortage of palladium and the likely rise in the palladium price. Investors have heard similar refrains from experts relative to rare earth elements, lithium and even some base metals. Those commodities have witnessed only what one might call sporadic price gains. Are you "crying wolf" when it comes to palladium?
Peter Krauth: The fundamentals for palladium's supply-demand profile are very solid. On the demand side, two-thirds end up in vehicles, mostly for catalytic converters. Car sales are growing very quickly. In 2011, 77M vehicles were sold worldwide; in 2012, 81M. This year, the forecast is to reach 85M and the 2018 estimate is 104M. A lot of that growth will happen in China, which also has a serious pollution problem. China has been increasing its emission standards as its air becomes relatively unbreathable.
On the supply side, Russia accounts for 44% of palladium production; South Africa for 38%.
South Africa has serious labor disruptions. Recent clashes between strikers and the police resulted in 46 deaths. Protests and strikes have multiplied since then. In January, some even decided to close and sell off several of their platinum mines. Labor problems and production costs have just become overbearing. The mines are not profitable anymore. That does not help supply.
Ore grades from Russia have been falling quickly. Output from Norilsk, the world's largest palladium producer, is declining. Russia also sells palladium into the physical market from Gokhran, its state repository. In 2010, as much as 1 Moz of the physical palladium—representing 15% of the global supply—came from Gokhran. In 2011, that dropped to 775 Koz and last year to 250 Koz. This year, Johnson Matthey forecast Gokhran will supply only 150 Koz. In four years, supply from Gokhran will have dropped from 15% of the global supply to only 2%. Some insiders say there will be no supply from Gokhran in 2014.
TGR: Are resource equities the best way to play palladium?
Peter Krauth: They are. Palladium's demand outlook is solid, and Russia and South Africa—source of 80% of the supply—will have a difficult time keeping up with demand. As a result, palladium prices will continue climbing. That will attract investors to things like palladium ETFs. As those ETFs use the metal as backing, it will drive up physical demand further.
The equities provide leverage to the palladium price. If companies can mine palladium at a relatively low cost, they can generate healthy profit margins. That is how investors should play this trend.
TGR: Why have we not seen a pure PGM royalty play?
Peter Krauth: The market for a pure royalty play in PGMs is probably just too small for a given royalty company to focus solely on these metals; its growth opportunities would be limited.
There are few PGM projects being developed. PGMs are found in places that are not the best or most attractive places to work. Outside of South Africa and Russia, there are relatively few viable locations, therefore, there are very few PGM projects coming onstream in the next two years.
TGR: Large-cap royalty plays in the precious metals space have had a pretty good run. Some are trading around 21 times projected 2013 cash flow. Is there still value there?
Peter Krauth: I think so. Some are trading at relatively high P/Es, but there is opportunity. First, along with other precious metals equities, they have sold off to some extent. Second, and more important, they are being valued using gold prices that are probably too low.
The average analyst thinks that gold will average somewhere around $1,500/oz by 2015. They may be right, but if you look at their projections since 2007, analysts have regularly underestimated the gold price by several hundred Dollars.
Inflation and money printing by central banks will not back down. Precious metals royalty companies will certainly come back quite strongly as gold continues to rise.
TGR: What do you make of the royalty space?
Peter Krauth: This is a great space. Royalty companies will continue to perform very well over the medium and long term. I definitely want to maintain exposure to precious metals royalties.
TGR: Do you have some parting thoughts for us?
Peter Krauth: We are in a secular resource bull market that still has lots of legs and will last several more years. The imprudent behavior of central banks printing copious amounts of fiat money just makes serious inflation more of a threat to people's savings.
Commodities tend to be a strong beneficiary of inflation. I think everyone needs some exposure to commodities. But there is the element of cyclicality for all resources; at any given point in time, it makes sense to be in certain resources or to play them certain ways over others.
TGR: Peter, thank you for your time and your insights.