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Daily Intelligence Briefing – October 9, 2017

FEATURED TOPIC: PALLADIUM’S MOMENT TO SHINE – MRP Adds Long Palladium as a New Investment Theme

Palladium’s moment to shine has arrived. For the first time since 2001,the rare metal reached price parity with platinum, and there are further tailwinds ahead due to improving demand and supply fundamentals.

As well as being precious metals, palladium and platinum serve the industrial purpose of helping scrub emissions from catalytic converters in motor vehicles. Palladium is primarily used in gasoline-powered cars, whereas diesel-powered vehicles require platinum. Recently, the demand picture for these two metals has diverged as emissions control policies have tightened around the world. Air quality issues in Asia, a concerted effort to slow global climate change, and furor in the wake of Volkswagen’s emissions scandal have greatly increased the appeal of new energy vehicles that pollute less.

While electric engines – which do not require catalytic converters – are the long-term goal, the real shift is not yet toward 100% electricity, but rather lower emissions. Because diesel engines release a larger amount of emissions than others, they are falling out of favor, as evidenced by the precipitous drop in sales and market share of diesel cars over the past year. The shift is especially apparent in Europe, where diesel has historically been more popular in consumer vehicles than the gasoline engines that are prevalent in the U.S. and China. During the first half of 2017, diesel’s market share fell from 50.2% to 46.3%. In contrast, gasoline cars sales rose from 45.8% to 48.5%, marking the first time since 2009 that sales of gasoline cars have overtaken diesel in Europe.

It is true that “diesel fear” is also benefitting the electric and hybrid car markets, and that  several governments are looking to ban fossil fuel vehicles in the future. However, gasoline cars will continue to be the go-to for most consumers for years to come. That’s because the real growth of the worldwide auto industry is in the developing markets, and it’s a challenge to go fully electric in those markets where affordability and energy infrastructure present significant barriers. Although U.S. auto sales are expected to decline 3.6% in 2017 and 0.6% in 2018, Moody’s predicts an uptick in key markets like China, Japan and India. China and India’s still-low vehicle penetration rates and continued economic expansion could push auto sales growth beyond the low-single-digit range over the next five years. Demand is also poised to bounce back in recently dormant markets like Brazil, Argentina, and Russia as their respective economies emerge from recession.

Hybrid cars, which also use gasoline and therefore require palladium-based catalytic converters, will continue to capture market share thanks to the many incentives that are being offered to citizens in the major car markets. In fact, plug-in hybrid electric vehicles (PHEVs) constitute the fastest growing segment of new energy cars, since they are considered a gateway to fully electric cars.

Meanwhile, there are supply constraints to deal with. Since 2011, demand for palladium has outpaced mining production, making 2016 the fifth consecutive year of a global production deficit. This year is no different. Russia-based Norilsk Nickel, the world’s leading producer of palladium, reported that its palladium production in the first half of 2017 fell 2% compared to a year earlier, to almost 1.3 million metric tons. The company said palladium consumption is expected to reach an all-time high of 10.8 million ounces, and is forecasting a deficit this year of more than 1 million ounces. Societe Generale projects a supply deficit of 1.8 million ounces this year, then 1.9 million next year. Indeed, on the New York Mercantile Exchange (NYMEX), palladium stockpiles have fallen by more than 40% this year to their lowest level in about 14 years.

There’s also an investment side to the story. Geopolitical issues tend to push funds into “safe-haven” assets such as precious metals. Concerns relating to Brexit, the Trump Presidency, North Korea, and recent elections in Europe have sent investors into gold and silver ETFs. Palladium may begin to see some of those flows as well. Maxwell Gold, director of investment strategy at ETF Securities, notes that investors have “remained mostly absent until recently with a three-year high in [exchange-traded fund] inflows in August… If investors begin to move into the market en-masse, prices may move to new records, thus creating a new leg in the current rally.”

NEW MRP THEME: Given the positive demand outlook and indications that the market could face a shortage in coming years, MRP is adding LONG PALLADIUM to our list of active investment themes. Palladium has already enjoyed a stellar rally year-to-date, with the spot price and the ETF both up over 30%, however, we believe there are further gains ahead as the demand side of the theme is supported by secular shifts within the massive auto industry. Our view is that, because there are still multiple barriers to the global car fleet becoming fully electrified, there will be a yawning demand gap between diesel and electric-only engines. That gap will be filled by gasoline and hybrid vehicles which rely on palladium-dense catalytic converters.

There are a couple of caveats to consider. First, palladium relies on the automotive industry for almost 80% of its demand, so a global downturn in the auto sector could cause prices to plunge. As you can see in the first chart below, the Palladium ETF (PALL) tracks the autos ETF (CARZ) quite clearly. The second caveat is that three quarters of the world’s supply comes from Russia and South Africa. If either is suddenly able to jack up output, that would also put pressure on the price of palladium which has been known to exhibit high volatility in the past. When the last bull market in palladium ended in 2001, the metal was trading around $1,055 per troy ounce. By 2008, during the financial crisis, it fell to $170. Now it is back above $900. Bottom line, the LONG PALLADIUM THEME is not for faint-hearted investors.

HERE in the meantime are the latest articles on palladium (the stories are summarized in the COMMODITY Section)

  • Metals – The surprising ways to cash in on the electric-car boom
  • Metals – Palladium: The Year’s top performer so far
  • Metals – Palladium Hits Parity with Platinum
  • Metals – Palladium Market Expansion to be Persistent During 2015 to 2021
  • Metals – Platinum Gets Mangy

CHART: ETFS Physical Palladium (PALL) vs. ETFS Physical Platinum (PPLT) vs. SPDR Gold Shares (GLD) vs. PowerShare DB Base Metals ETF (DBB) vs. First Trust NASDAQ Global Auto ETF (CARZ)


OTHER STORIES HIGHLIGHTED IN TODAY’S DIBS:

  • Markets: 
    • Stocks – Chinese share boom obscures governance flaws 
  • Economics and Trade: 
    • India – A Commodity Superpower Asks What If India Really Is Next China? 
    • India – EU pivots east as free trade deal with US stalls  
  • Politics and Policy: 
    • Brexit – With May’s Leadership in Doubt, Four Scenarios for Brexit 
    • Catalexit – Spain passes law making it easier to move business out of Catalonia 
    • Iran – Trump Expected to Refuse to Certify Iran’s Compliance With Nuclear Deal  
    • Cyber Defense – Russian Hackers Stole NSA Data on U.S. Cyber Defense  
  • Services: 
    • F&B – France to Make Least Wine in 60 Years After Bad Weather Hits Grapes
    • F&B – New technology on the road set to revive alcohol sales, says Morgan Stanley
  • Transportation:  
    • Autos – German car sales seen topping expectations on incentives  
    • Autos – Brexit Chills Car Sales in First September Drop Since 2011 
    • Autos – New cars increasingly crammed with distracting technology 
    • EVs – Electric vehicle race is on in Southeast Asia  
  • Commodities: 
    • Biofuels – Biofuels phase-out will raise demand for feed imports, industry warns
    • Metals – Electric cars prompt consultants CRU to explore cobalt sulphate index  
  • Endnote: 
    • Other web service data breaches pale in comparison to the 3-billion user Yahoo hack

JOE MAC’S MARKET VIEWPOINT

CURRENT MRP THEMES

  CAPEX  (L)

  Cybersecurity  (L)

  Defense  (L)

  Emerging Markets  (L)

  France  (L)

  Gaming  (L)

  Gold  (L)

  Homebuilders  (L)

  India  (L)

  Oil Services & Equipment  (L)

  Oil & U.S. Energy  (L)

  Steel  (L)

  TIPS  (L)

  Long Dated Treasuries  (S)

  Robotics & Automation (L)

  U.S. Financials, Regional Banks  (L)

  Lithium (L)

  Value over Growth  (L)


About the DIBs: MRP focuses on identifying transformational change in the global economy and offering an investment thesis whenever an opportunity arises that has not yet been recognized by the market. The DIBs are MRP’s compilation of articles and data from multiple sources on subjects reflecting disruptive change that have potential investment implications for an industry or group of securities. We share these with our clients who may already have or may be considering exposure in the industries affected. The subjects change daily and constitute an excellent update on featured topics. 

   MAJOR DATA POINTS

Top   

  • United States, Consumer Credit, MoM, AUG: $13.1 B from prior $18.5 B
  • United States, Baker-Hughes Rig Count. WoW, wk10/6: 936 from prior 940
  • United States, Employment Situation, MoM, SEP: -33,000 from prior 156,000
  • Estonia, Inflation Rate, YoY, SEP: 3.7% from prior 3.9%
  • Norway, Industrial Production, YoY, AUG: 6.7% from prior 0.5%
  • Kenya, PPI, YoY, Q3: 5.44% from prior 6.44%
  • Luxembourg, Inflation Rate, YoY, SEP: 1.76% from prior 2.0%
  • Seychelles, Inflation Rate, YoY, SEP: 3.24% from prior 3.94%

   MARKETS

Top   

Stocks – Chinese share boom obscures governance flaws 

Chinese shares have been big outperformers this year, but this should not dazzle investors into assuming that the corporate governance of Chinese companies is similarly stellar. In the year to September 29, the MSCI China Index posted gross returns of 43.41 per cent, better than any other country covered by MSCI’s suite of indices and markedly superior to the 17.8 per cent return on MSCI’s benchmark All Country World Index (ACWI). The MSCI China index includes 149 shares listed in Hong Kong, the US and elsewhere.

However, breaking down the China index into laggards and leaders reveals not only a vast divergence in performance between state-owned enterprises (SOEs) and non-state Chinese companies. It also shows that even some of the most turbocharged performers are subject to serious governance risks.

On average, total shareholder returns for non-SOEs included in the MSCI China index over the past five years have been 227 per cent, nearly three times higher than the 85.4 per cent returned by SOEs in the same index (see chart). The reasons for the lacklustre SOE showing in China, which is mirrored in SOE underperformance worldwide, are familiar to Beijing policymakers who have wrestled with low effciency, overstaffing and misallocation of resources in the state sector for decades. FT  

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   ECONOMICS AND TRADE

Top   

India – A Commodity Superpower Asks What If India Really Is Next China? 

India has the potential to boost consumption of everything from copper to iron ore as its economy expands over the next two decades and more people flock to its cities, according to projections from the Australian government that try to fathom whether the country will emulate China.

The expansion of India’s economy is drawing rising interest from resource-rich exporters including Australia, the worlds largest shipper of iron ore, as well as mining companies such as BHP Billiton Ltd. keen for new opportunities as the pace of China’s growth cools. According to the Australian study, while India’s development is likely to be less resources-intense than China’s, there’s still significant scope for increases in commodities consumption. B  

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India – EU pivots east as free trade deal with US stalls  

Officials from Brussels have given their support to sealing a free trade deal with one of the world’s fastest-growing economies at the14th EU-India Summit in New Delhi. Both sides also agreed to strengthen security links. The president added that visible trade is almost perfectly balanced with exports and imports nearly equal on both sides.

Negotiations on the proposed EU-India Broad-based Trade and Investment Agreement (BTIA) started in 2007. However, they have repeatedly failed to reach an agreement on the deal, facing significant spats on such issues as intellectual property rights, and duty cuts in automobile and alcohol production. Talks with India resumed after the negotiations between Brussels and Washington on the Transatlantic Trade and Investment Partnership (TTIP) stalled after Donald Trump’s election as US president. RT

  POLITICS & FISCAL POLICY

Top   

Brexit – With May’s Leadership in Doubt, Four Scenarios for Brexit 

Theresa May’s leadership is in doubt after a difficult party conference marred by open divisions over Brexit and a calamity-stricken speech by the premier. At stake is Britain’s ability to strike a deal with the European Union with just 18 months until Brexit day. Here are four possible scenarios of how it could play out.

1. May Clings On  Rebels fail to secure enough support to topple May, with lawmakers calculating that a leadership battle will inevitably lead to another election that they may lose to Labour — which is ahead in the polls. May could try to stamp her authority on the Cabinet, possibly even by firing her rebellious foreign secretary, Boris Johnson.

2. May Is Ousted, Triggering a Leadership Race – May resigns. While there could be a consensus candidate that would avoid the need for a leadership race, divisions in the party make that unlikely. The party conference in Manchester this week underlined just how split the party is.

3. May Resigns and Davis Emerges as Consensus PM – Brexit Secretary David Davis could emerge as a consensus candidate, avoiding the need for a drawn-out leadership battle. While pro-Brexit, he gets some points from Remainers as a pragmatist, and would offer continuity.

4. A General Election: Corbyn Wins – But in such a febrile environment, a general election can’t be ruled out. Polls indicate that Labour would win. The party, which supports enforcing the referendum result, has a softer — if vaguer — approach to the split, wanting to keep access to the single market and possibly open-ended membership of the customs union. B

Catalexit – Spain passes law making it easier to move business out of Catalonia 

Spain’s fifth-biggest bank, Banco Sabadell has announced it will move its headquarters from Catalonia following threats by the region’s political leaders to declare independence. Two million Catalans voted to break away from Spain in last Sunday’s referendum. The Spanish government issued a decree on Friday making it easier for companies to move their legal base out of Catalonia. The EU’s rules provide rescue for unstable banks to protect their customers within the bloc. If Catalonia does succeed in breaking away, it could be shut out of the EU and its system of banking regulation. RT

Iran – Trump Expected to Refuse to Certify Iran’s Compliance With Nuclear Deal  

President Donald Trump is expected to refuse to certify that Tehran is complying with the 2015 international nuclear agreement, as part of a broader policy change on Iran to be set out as early as next week, people familiar with the deliberations said. That move would place key decisions about the future of the nuclear deal before Congress, which could move to reinstate sanctions under an expedited 60-day review process.

However, Congress may choose not to, people familiar with the discussions have said, as such a step could lead to the agreement’s collapse. Reimposing sanctions would be considered a breach of the accord’s provisions requiring sanctions to be lifted as long as Iran is deemed to be in compliance by international consensus. If Congress doesn’t take action, the outcome of the administration’s approach may be to accuse Iran of failing to comply with the agreement while leaving the deal in place. WSJ

Cyber Defense – Russian Hackers Stole NSA Data on U.S. Cyber Defense  

Hackers working for the Russian government stole details of how the U.S. penetrates foreign computer networks and defends against cyberattacks after a National Security Agency contractor removed the highly classified material and put it on his home computer, according to multiple people with knowledge of the matter. The hackers appear to have targeted the contractor after identifying the files through the contractor’s use of a popular antivirus software made by Russia-based Kaspersky Lab, these people said.

The theft, which hasn’t been disclosed, is considered by experts to be one of the most significant security breaches in recent years. It offers a rare glimpse into how the intelligence community thinks Russian intelligence exploits a widely available commercial software product to spy on the U.S. Having such information could give the Russian government information on how to protect its own networks, making it more difficult for the NSA to conduct its work. WSJ

  SERVICES

Top   

F&B – France to Make Least Wine in 60 Years After Bad Weather Hits Grapes 

French winemakers are lamenting the smallest vintage in 60 years after spring frost damaged vines at Bordeaux chateaus like Angelus and Canon La Gaffeliere, while summer storms caused grape rot in Champagne. Wine volume will fall 19 percent to the equivalent of about 4.9 billion bottles, the Agriculture Ministry forecasts. That would be the least since 1957.

France and Italy typically compete for the rank of world’s biggest wine producer, with weather a key factor. While Italian vineyards also suffered damage from frost, drought and hot weather, volumes are still expected to outpace those in France. The Italian association of wine-industry technicians forecasts output of 47.2 million hectoliters, compared with 36.9 million hectoliters for France.

Wine is France’s most valuable farming product, with value-added production of 11.5 billion euros ($13.5 billion) in 2016, according to statistics office Insee. It’s also the country’s top agricultural export with a value of 8.25 billion euros last year, with Bordeaux and Champagne in the lead. Despite lower yields across much of France, the Burgundy-Beaujolais region expects a 6 percent increase in the volume of wine carrying a regional label. B  

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F&B – New technology on the road set to revive alcohol sales, says Morgan Stanley 

A recent Morgan Stanley report forecast that the global alcoholic beverage market could get an extra US$98 billion boost by 2025 thanks to the advent of car-sharing and driverless cars. The report said the arrival of such technology is a “significant growth opportunity” for alcoholic drinks as the average global alcohol consumption growth rate is forecast to accelerate from 2.2 per cent a year currently to 3 per cent by 2025. Morgan Stanley also said the current global market size for alcoholic drinks is about US$1.5 trillion.

Zhu Danpeng, an associate with the China Branding Institute, said the harsh regulations on drink-driving in recent years has made an impact on the country’s Baijiu industry. However, one of the signs of recovery can be seen in Shanghai-listed shares of Moutai, the most valuable liquor company in the world, which have quadrupled since 2014. The shares have been trading within a record high range of between 510 yuan and 520 yuan since the beginning of October, making it the most pricey of China’s 3,100 traded stocks.

Moutai isn’t alone – other Baijiu stocks have been gaining momentum. The SWS Baijiu index has grown more than 50 per cent this year, surpassing the annual growth rate of the past three years, which has fluctuated between 23 per cent and 43 per cent. Chinese companies have been investing heavily in the development of self-driving cars. Search engine giant Baidu announced a US$1.52 billion autonomous driving fund last month as part of a wider plan to speed up its technical development and compete with US rivals. SCMP

 

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