Investors have made a fortune on palladium this year. So why are exchange-traded funds that track the precious metal hemorrhaging cash?
More than $49 million has left the two main U.S. and European palladium ETFs -- the ETFS Physical Palladium Shares and the ZKB Palladium fund -- or roughly 15 percent of assets through Aug. 21 this year, according to data compiled by Bloomberg. Across all ETFs, holdings of palladium have plunged from around 3.1 million ounces in 2014 to 1.6 million ounces today. And that’s while the metal has risen 38 percent this year to its highest price since 2001.
The explanation for the outflows lies in part in the scarcity of physical palladium and a robust borrowing market that has developed among users and speculators. Most ETFs that track stocks or bonds are fairly predictable in that flows typically correspond with performance. For funds that hold exotic assets like palladium however, quirks in the underlying market can often lead to more unpredictable patterns.
"This is different from the traditional ‘palladium is up, so let me buy it’ type sentiment," said Eric Balchunas, a Bloomberg Intelligence analyst. "There’s more intrigue here than usual."
Small, Opaque
To understand what’s happening, you’ve got to dig into the small, opaque world of the metal itself and the myriad ways sophisticated investors are using commodities ETFs. A platinum group metal, palladium has a variety of uses including in jewelry and dentistry, but a good deal of it ends up in automobiles to clean exhaust gases from gasoline engines.
Demand for such engines has soared in the wake of Volkswagen AG’s diesel emissions scandal, which has led to "tightness" in the market for physical palladium and contributed to scarcity, according to Michael Widmer, head of metals markets research at Bank of America Merrill Lynch in London.
Supply is set to trail demand by the most in at least seven years, according to researcher Metals Focus, while inventories in warehouses tracked by the New York Mercantile Exchange have shrunk by 45 percent this year.
The shortage of physical palladium is driving companies to seek out alternative ways of acquiring it. One way that has become increasingly popular is to pull together a bunch of shares of the ETF and redeem them with the issuer in exchange for an equivalent amount of the precious metal, minus costs.
"If the spot market is tight and it’s tough to get the metal, yes it makes sense to pay the extra cost of pulling supply from ETFs," said Ryan McKay, a commodity strategist at TD Securities in Toronto.