Commodity ETF Alert March 2010 Issue

No, I’m not talking about something as obvious as the key or the tires.

What I’m talking about is much more inconspicuous.

As a matter of fact, you probably wouldn’t even know it was there unless somebody told you.  Yet, it’s a part of every car rolling off the assembly line…

What the heck am I talking about?

I’m talking about the catalytic converter.  It’s a device located on your exhaust system and it’s required on all cars and pickups.

It’s also required on all semis, tractors, buses, and trains as well.  In fact, almost anything having a combustion engine is required by law to have one.

Now, the catalytic converter isn’t essential to your car actually being able to run.  But it is essential to your car being able to run cleanly.

You see, the catalytic converter has the job of cleaning up the exhaust emitted from your engine.

When you step on the gas pedal, fuel is supplied, ignited, and gasses are released into the exhaust system.  The act of combustion creates power for your car.  But it also creates some nasty toxins that harm the environment…

And that’s where our pick for this month comes in. We’re going to buy palladium…

Palladium is a rare metal used to coat the inside mesh of a catalytic converter.  When the exhaust fumes from the engine come in contact with the palladium, a chemical reaction occurs.

This reaction turns carbon monoxide and nitrogen oxide (harmful) into nitrogen, carbon dioxide, and water vapor (less harmful).

Palladium is part of a group of metals known as the Platinum Group Metals, also known as PGM.  The PGM’s consist of platinum, palladium, ruthenium, iridium, rhodium, and osmium.  All these metals have similar chemical properties and are used to produce many products.

Russia is one of the largest producers of palladium. South Africa, the U.S., and Canada are also big producers.

Now, some of you may be thinking this really isn’t all that exciting of an investment. Buying some commodity found in the guts of everybody’s cars may not peak your interest.

But hold on a second, read this…

Palladium is also used widely in electronics.  Products like computers, cell phones, and LED/LCD televisions.  It also plays a role in groundwater treatment and hydrogen purification.  And let’s not forget dentistry and medicine.

As you can see, palladium has many uses…

But the main use of palladium, which uses upwards of 50% of available supplies, is in catalytic converters.  And with the resurgence of the U.S. auto market, as well as growing demand for cars in emerging markets (like Brazil), demand for palladium is going to see constant growth.

Here’s where it gets interesting…

The American investor is just now becoming aware of the opportunity in palladium. Why now?  A new ETF has just arrived in the U.S. allowing anyone to invest in palladium.  It’s called the ETFS Physical Palladium Shares (PALL).

Investors in Europe have been able to invest in this ETF for years.  But it was just recently made available for purchase here in the U.S.

This new ETF invests in physical palladium.  That is, they buy the actual metal and hold it in secure vaults for the investors in the fund.  One share of the ETF gives the investor a metal entitlement of 0.1 ounces of palladium.  (It may not sound like much but remember, on the open market, palladium sells for $463 per ounce.)

Here’s what’s likely to happen…

This new ETF is going to have a serious impact on palladium inventories.  Companies using palladium to produce products (such as catalytic converters) will be in direct competition with the fund to acquire palladium.  Remember, PALL actually holds the physical metal.  It doesn’t use futures contracts like some other ETFs do.

Since palladium is a rare metal in the PGM, large increases in the demand will have an effect on the price.  The more people investing in PALL, the more physical metal the managers of the fund have to secure in their vaults.

This goes back to basic supply/demand.  Higher demand for a commodity translates into less supply and therefore a higher price.

This increased demand is going to come from the American investor.

That sounds great but is it really that simple?

Well, yes and no.  Let me explain…

The opening of this new ETF to the American investor will have an effect on palladium prices in the coming months.

But obviously, there are other factors affecting the price of palladium.  I don’t want you to think the price of palladium is going to go straight up just because the average Joe is investing in PALL.

Normal business activities, such as producer hedging activity, will also have an effect on the palladium prices.  The perceived strength of the U.S. automobile market and economy in general will also play a role.  Remember, palladium is a primary ingredient in many catalytic converters.

The bottom line is this…

Palladium is a rare metal with many industrial uses.  As the global economy recovers from the severe jolt of the credit crisis, demand for industrial palladium will grow.

But let’s also consider this…

Just like gold and silver, palladium is a precious metal.  And it’s also considered a hedge against inflation.  Investors protecting themselves from a falling dollar (rising inflation) look to hard assets to protect their wealth.  And PALL is another way to diversify their hard asset portfolio.

ABOUT PALLADIUM

As I said above, ETFS Physical Palladium Shares (PALL) holds physical palladium. One share of PALL entitles you to 0.1 ounces of palladium.  The ETF is traded on the NYSE Arca exchange.

TECHNICALLY SPEAKING

Take a look at the chart…

We’re getting in on this ETF relatively early.  PALL is likely to be volatile for at least the next few months.  I don’t recommend you buy a full position at this price.  Buy half of your position here and now, below $47.75.  Then wait to see what happens…

If PALL falls back to the mid or low $40s, then add the rest of your position.  On the other hand, if PALL rises from here, add the remainder of your position on a pullback in the price.

 WHAT TO DO NOW:

ETFS Physical Palladium Shares (PALL) is trading at $47.21.
Buy PALL up to $47.75 per share.
Our Profit Target is $57.00.
Don’t forget your position sizing.

ENERGY COMMODITIES

Crude oil is back above the $80 a barrel mark.

Crude prices are moving on a number of fundamental issues.  Most importantly, the strength of the economy and the demand for crude oil products.  The continued strength of the economic recovery is still in question, yet crude is back at 52-week highs.

So something else is driving crude right now…

Technical levels are also of importance in crude trading but we can’t leave out geopolitical risks.  Any possibility of future restrained supply will put a “fear premium” in oil prices.  And right now the issues with Iran are jacking up oil prices.  Each month it seems there is more rhetoric and saber rattling from the Iranian president.

Just how much is the fear premium?  Well, nobody can be exactly certain.  But we’re positive it’s there.

The short term uncertainty of the economy suggests lower prices for crude.  But add in the long term supply/demand views and the situation with Iran, and oil prices are likely to stay elevated.  Keep holding our position in OIL for future gains…

GRAIN COMMODITIES

Grain prices haven’t moved much since our initiation of the JJG trade in our last report. As we get further into the spring planting season, we should see JJG move higher.  JJG has technical support at $35.

INDUSTRIAL METALS

Industrial metals rebounded over the last month.  These metals move in tandem with perceived economic strength or weakness in global economies.

The news on the economy has been mixed lately.  One day we’re seeing news about how weak the economy still is, yet other days, we see news suggesting the economy is regaining its sound footing.

Copper has risen significantly since its deep pullback in early February.  It’s now testing the highs from earlier in the year.  Industrial metals are likely to remain choppy in weeks and months to come until a clearer picture of the economy is seen.

Remember, we closed our position in Aluminum (JJU) in our mid-month update for gains of around 10%.

PRECIOUS METALS

Gold and silver have been rising recently, even in the face of a strong dollar.  We still believe there’s a lot of room to run.

However, in the short term, the correlation between stocks and gold has been very high.  If stocks go into a range bound market, gold and silver are likely to do so as well.  But at some point, we’ll see a catalyst pushing precious metals much higher. Keep holding our positions in IAU and SLV, leaving them open for further upside.

SOFTS

Cocoa and sugar are pulling back significantly in the past month.  Both of these commodities exhibit seasonal weakness from March into June.  Coffee continues to remain weak as well.

LIVESTOCK

COW has managed to trade higher in the past month.  It finally broke out of its trading range from last August.

However, live and feeder cattle tend to exhibit seasonal weakness from mid-March into June.  Large supplies of fattened beef come onto the market out of feed lots from the Midwest.  This effect should limit the upside of COW in the coming months.

• This month we’re adding Palladium (PALL) to the portfolio.  See above for all the details.

Category: Commodity Trading