Rhodium: The Fifth Element

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By Joshua Enomoto, Founder of ContangoDown.com

For alternative-investors that have perused or referenced Kitco.com’s price updates, their basic knowledge of the four major precious metals can be reasonably assumed.After all, CNBC routinely displays the “Fab Four” of gold, silver, platinum and palladium on their rotating ticker. But Kitco’s inclusion of the fifth element, rhodium, has undoubtedly raised a few eyebrows, if not for sheer curiosity then the seemingly static spot-price. Many come to the conclusion that rhodium investment is a cute oddity, perhaps for the ultra rich or the perpetually dateless, but ultimately, an investment that fails mass marketability.

Such concerns carry significant validity: when there is a lack of price movement for a particular asset, it usually implies a thin market. For rhodium, the market is downright anorexic. As of this writing, this author is aware of only one rhodium ETF in existence, Deutsche Bank’s XRHO, which is traded in the London stock exchange. While it is 100% backed by the underlying physical asset and is designed to track the spot-price denominated in US dollars, the illiquidity of the rhodium market as implied by the sole uniqueness of the aforementioned ETF is a turn-off to most investors.

Before we completely write off this opportunity, let’s consider some comparative analysis. In recent years, the mining output for silver has grown quite dramatically as the technology to extract and refine greater quantities of ore has increased. Current global mining output stands at around 800 million troy ounces, with government reserves and recycled scrap pushing the total output to nearly 1 billion. This rise in production equates to an annual”inflation” of silver supply at 2.8%, yet total demand has only increased by 0.6% annually, according to numbers provided by Thomas Reuters GFMS:

The shortfall in demand is a result of declining consumer interest in the traditional uses of silver: photography, jewelry, and silverware (abbreviated as “PJS” in the above chart). Industrial demand for silver, while strong, has been flat over the last five years. The one bright spot is investment demand, which has picked up dramatically since 2007, despite tremendous losses suffered in the spot market during the 2008 financial collapse. The ubiquity of silver gives it marketability leverage, rivaled only by gold and crude oil, which should be supportive of higher prices as fears of fiscal impropriety continues to weigh heavily on investors even as the consumer retail demand has generally exited the sector.

Rhodium, on the other hand, is a pure supply play: less than 800,000 ounces of the obscure element is mined annually, while demand sits at 750,000, giving this rare metal a global market capitalization of less than $1 billion USD (@ spot price of $1,150/toz). To put this into perspective, it would take 987 years of mining rhodium in order to quantitatively match one year’s worth of production for silver (assuming 2012 mining output capacity). Because of its rarity, mining companies only produce rhodium as a by-product: therefore, the supply is directly correlated with platinum and palladium production, which are the more common (and marketable) PGM’s, or Platinum Group Metals. Most of the usage of rhodium (80%) is centered on catalytic converters, especially for diesel engine applications where alternatives are non-existent. It has been speculated that the introduction of Deutsche Bank’s ETF has spurred auto makers to quietly load up on rhodium as a means to hedge against potential price fluctuations as the gate to a previously exclusive market has been opened, albeit slightly.

However, slightly may be all that’s needed, considering the tiny sector. While conservative investors find strength in numbers, a voluminous market is difficult to move. With rhodium’s physical market cap estimated to be only $862 million, large players can easily swing the spot-price skyward. The speculation, therefore, is not whether such entities can influence the sector, but rather, if they want to. And such desires may be realized, considering the potential opportunity:

In a little over three years (between 2005 – 2008), the spot-price of rhodium increased nearly ten fold, resulting in an average annual return of 240%. Interestingly, the spot-price of platinum rose in lock-step with rhodium, further confirming the supply dependency of the latter element with the former. Both metals demand structure is heavily tied to industrial usage, which obviously took a beating during the financial meltdown. Rhodium, being more dependent on the automotive sector, extracted a heavier toll than its PGM-cousin, resulting in a flat-lining of the spot-price at around the $1,000/toz level.

However, the automotive sector has been picking up, especially in the Land of the Rising Sun, where a weaker Yen has made Japanese exports far more competitive. Toyota Motor Corporation, which was one of the brighter stocks of 2012, is now within 17% of its all time high of nearly $140. While a technical pull back in TM shares is likely in the short-term, the long-term fundamentals are very bullish. This bodes well for platinum and palladium demand, which in turn should have a positive influence on rhodium.

For the supply-side perspective, one country is at the heart of the matter: South Africa. Many of its cities are well-known for its murderous violence just as it is for its natural beauty. Unreported cases of “white genocide” continue to cast a moral and societal plague on a country that is simultaneously on the brink of greatness and disaster. Such dichotomy is perhaps no more evident in their mining sector: while awash in natural affluence, class and racial politics combust quite frequently, leading to labor strikes and sometimes fatalities. As most of the world’s supply of rhodium comes from South Africa, a consistent stream of inventory is nowhere near guaranteed, giving further weight to the bullish speculator.

Still, rhodium is a mixed-bag. While the rarity and volatility of supply is nearly guaranteed to move the spot-price higher, the question remains, how high will it go? Because the bid/ask spread is so wide in the rhodium sector, the cost margin is too prohibitive for most investors. Also, because the thin market rarely fluctuates, long months, perhaps years can pass before any action is evident. This could test the resolve of even the most patient investor. However, the opportunity is still enticing: one major event could send valuations soaring and volatility over the long-term is very limited. For those that truly understand the risk, rhodium could represent a valuable ally in your portfolio!

This idea is SPECULATIVE.
FMT Suggestion: BUY Physical Rhodium or if you have access to the London Exchange use the ETF XRHO.

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