scotia precious metals forecast 2013 pgmforecast2013

7/29/2019 Scotia Precious Metals Forecast 2013 PGMForecast2013

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ScotiaMocattaTM

Precious Metals 2013 ForecastPGM November 2012

scotiamocatta.com

Executive Summary

Platinum and Palladium prices have oscillated in broad ranges over the past 12months. This suggests there is good underlying buying and overhead supply.Expect more of the same until the fundamentals tighten.

The demand outlook for PGMs is not bullish in the short term, but we feel thesupply situation is looking more bullish now with labour unrest in SouthAfrica.

Fund interest in the PGMs has shot higher on developments in South Africa,there is now a risk of stale long liquidation in the short term.

Investor interest in Platinum remains robust, it has not been so strong forPalladium, but interest in the Rhodium ETF is growing.

Industrial demand for all metals is expected to be lacklustre in 2013, as a lotof capacity was built in 2010 and 2011.

We are mildly bullish basis the demand outlook, but are more bullish giventhe potential for supply disruptions in South Africa. We expect steady investorinterest as 2013 unfolds.

Platinum

IntroductionThe post 2008 recession rally for Platinum was exceptionally strong and given itsstrength it is not surprising that prices have corrected and consolidated at lower levels,especially considering the global economic climate is not strong, as seen by thenegative trends in most manufacturing PMI indices. Support was found in December2011 at around $1,340/oz and over the summer support came in at a higher level

around $1,380/oz. As such, it looks as though the market has found a base. Investmentinterest has been strong in Platinum and that can be seen by the near record holdingsin the ETFs. With the supply side of the market also looking more vulnerable withlabour unrest in South Africa, the macro and momentum funds have returned to themarket with a vengeance. Although their large bullish position may be a threat to theup trend in the short term, it does suggest that the funds are once again interested inPlatinum and as such, even if they take profits in the short term, we feel their potentialto get long again at a later date will again be a bullish factor for the metal. Demandseems to have settled down following the gyrations seen in 2008 and 2009 andalthough the outlook for the auto industry is looking mixed, we feel there is potentialfor the worlds two largest auto markets to grow at a faster pace in 2013, which inturn should be good for PGM demand, although it may impact Platinum the least.Overall, our base case is for a better economic outlook in 2013 and that shouldsupport Platinum prices, but given the potential for crises to unfold in Europe, China,the US and Middle East there is no room for complacency.


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Precious Metals Forecast PGM November 2012

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DEMAND

Platinum demand comes from three distinctsectors industry (the main user being the autoindustry, but also includes the electronicsindustry), jewellery manufacturing and investors.

This diverse group of buyers provides thePlatinum market with numerous swing factors thathelp to regulate supply and demand during theeconomic cycle as each group is motivated bydifferent events. Demandfrom the jewelleryindustry tends to be price elastic, while demandfrom industry tends to be inelastic. However, industrial demand is also prone to destockingwhen the economic outlook deteriorates as was seen in the second half of 2011. Investmentdemand via exchange traded funds (ETFs) continues to climb, there have been bouts ofredemptions along the way, but with holdings near record highs investors are still bullish.

Platinum demand has had a volatile time since August 2011, the downward moves have

reflected concerns about the economic outlook, while there have been some sharp rallies on theback of policymakers decisions to support the financial system. The rally at the start of 2012,was prompted by the ECBs plan to bolster the regions banks by means of a long termrefinancing operation (LTRO) that enabled banks to borrow money for three years at onepercent. The market saw as a form of backdoor quantitative easing that lifted the prices of allcommodities. The continued strong recovery in US auto sales also helped demand forPlatinum in the early months of 2012, until sales started to slip again after peaking at 15.1million units in February. However, with Chinese auto sales getting off to a poor start in 2012,with January and February sales falling 4.4%, compared with a year earlier, and as it becameapparent that the vast majority of the 489 billion of LTRO funding was sitting on banksbalance sheets and not being put to work in the economy, sentiment began to wane. This put anend to the January to February rally that peaked at $1,937/oz and was followed by a steadyretreat back to the $1,380/oz level. The bulls reappeared again in mid-August when the marketstarted to expect further broad based quantitative easing; this also coincided with a pick-up inlabour unrest at South Africas Platinum mines. The result was a fast rally that took pricesfrom around $1,380/oz to $1,730/oz - a 25% move. Given the demand outlook remains largelysubdued other than for the auto market in the US, we now feel that the bullish factors in themarket are likely to be more to do with supply than demand. That said, after prices turneddown in late February and given the extended period of sideways trading over the summer, wewould expect consumers to be holding low levels of stocks. This suggests further bouts ofdestocking are likely to be relatively mild, while dips may also attract restocking given thetighter supply outlook.

Autocatalyst DemandPlatinums use in autocatalysts accounted for 38% of total demand in 2011. In 2007, before thecredit crisis, autocatalysts accounted for 50% of demand. This drop highlights twodevelopments - firstly that auto sales have not recovered from the boom times seen between2004 and 2007 and secondly that Platinums use in autocatalysts is suffering substitution fromcheaper Palladium. Between 2004 and 2007, US vehicle sales were running at an annualisedrate of around 17 million units, compared with an average of 14.4 million in the first ninemonths of 2012. The amount of Platinum used in autocatalysts in 2011, however, was 25%below what was used in 2007, while demand for Palladium from the autocatalyst industry in


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2011, was 66% higher than what it was in 2007. The change in demand for these two metals isnot all down to substitution; demand for Platinum autocatalysts has also suffered due toregional trends. In Europe, diesel vehicles have a bigger market share than petrol vehicles andin Japan autocatalysts, whether diesel or petrol, tend to still have a high Platinum weighting.Due to the economic hardship in Europe and Japan, vehicle production and sales have laggedbehind other countries and that in turn has been a negative for Platinum demand, relative to

Palladium, from the auto industry. Given the strong yen, which makes Japanese exports lesscompetitive and with no end in sight to economic hardship in Europe, we feel the outlook forPlatinum based catalytic convertors will remain depressed in 2013.

Whereas Platinums use in autocatalysts for light vehicles has been subdued, its use in heavydiesel autocatalysts has grown strongly as the recovery in 2010 and 2011 prompted freightcompanies to rebuild their fleets of heavy trucks. However, following this strong bout ofgrowth, this sector of the industry may now be in for a quieter time.

Global auto sales for light vehicles are expected to grow 2.9% in 2013, according to MoodysInvestors Service - their earlier forecast, made in January, was for growth of 4.5%. Europeansales are expected to fall 8% in 2012 and to fall 3% in 2013. Chinese vehicle sales are expected

to grow 8.5% in 2013, down from an earlier estimate of 10% growth, but up from an expected7% in 2012. With growth in India, Brazil and other emerging economies subdued as worldtrade slows, demand for high priced items, such as cars, is suffering and that is likely to remainthe case until China starts to recover and world trade follows. The one bright spot is the US,where LMC Automotive is forecasting auto sales of 14.3 million units in 2012, which wouldbe a 12% rise from 2011. They expect auto sales to reach 15 million units in 2013, whichwould be 4.9% above 2012s level.

Other Industrial UsesPlatinum is used in an extensive range of other products and applications, which include use inthe glass, electronics, non-road emission control equipment and industrial manufacturing.Collectively these industries accounted for some 25% of total Platinum demand and 37% ofPlatinums industrial demand. Demand from these industries recovered strongly in 2010, asnew capacity was built as the recovery from the 2008-2009 recession seemed sustainable andas new technology, such as tablet computers, became mainstream products. In addition, therewas some ongoing stock building to take advantage of relatively low prices. This sector wasgrowing at a steady rate of 6% per annum between 2004 and 2007, but demand fell 6.7% in2008 and 34% in 2009 as the recession bit. It recovered 48% in 2010 and then tailed off to astill impressive growth rate of 15% in 2011. However, given further concerns over therobustness of growth in China, Japan and other parts of Asia in 2012, the markets seem lessconfident about building new capacity so we would expect demand growth to slow down thisyear. In 2013, we expect global growth to remain subdued as there now seems to be a lot ofover capacity in the global manufacturing system.

On balance, as these industries are all growth industries, we feel they will not suffer for long.In addition, there are other non-economic forces affecting the market. For example, newlegislation is being introduced to regulate emissions on static and non-road engines which issupportive of higher demand. Furthermore, some industrial applications that use preciousmetals have been trending towards using a higher amount of metal to increase efficiencies ofthe products that they either produce or that are utilized by the ultimate manufacturer.


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J ewellery DemandPlatinum jewellery demand peaked in 2009 at 2.81 million ounces as the rapid sell-off inprices, during the financial crisis, boosted jewellery demand. The 36% increase in demandbetween 2008 and 2009 highlighted the price elasticity of the jewellery sector. The higherprices seen in 2010 and in the first part of 2011, did weigh on jewellery demand, but much of

that was also probably due to pent-up demand and restocking being satisfied in 2009. Thejewellery market has faced numerous cross currents in recent years. On the one hand economichardship has led to less spending on luxury items, but on the other hand with prices in 2012lower than in 2011 and with Platinum prices below those of Gold, there have been incentivesto buy Platinum jewellery. That said, for those looking to buy jewellery as an investment, thefact Platinum prices have fallen below those of Gold could be a deterrent as they couldconclude that Platinum jewellery does not hold its value as well as Gold does.

Regionally there has been a mixed performance, demand in Europe was flat in 2011, butdemand is likely to suffer in 2012 and 2013 as austerity bites. In North America, demand fromthe high end of the market and the bridal sector were strong in 2011, but economic hardshipweighed on the retail end of the market. Looking forward, with the US recovery continuing we

would expect demand to remain steady. In China, demand has held up well with lower averageprices encouraging buying, while the opening up of more jewellery stores has increased theamount of stock required. Given good potential for further organic growth in China and thefact demand managed to grow around 2% in 2011 - even in the face of a slowing economy, itsuggests that the market will generally remain robust. We would also expect to see strongergrowth once GDP starts to pick-up again.

Overall, we would expect global jewellery demand to see moderate growth this year aseconomic hardship is countered by lower prices and Platinums price discount to Gold, but wewould expect stronger demand in 2013 as the recovery in the US continues and as ChinasGDP growth stabilises before recovering. In Europe, we expect the high-end of the market totake advantage of the lower prices and price differentials, but for the retail market to continueto suffer.

SUPPLY

2012 once again highlighted how critical South African production is to the Platinum market.Labour unrest turned ugly in August at the Marikana mine when police opened fire on riotingworkers and that helped fuel a 25% rally in prices. Although PGM prices were at the time alsobeing bought in anticipation of more QE, along with other commodities, the disruption to PGMsupply added to the price reaction. For example copper prices during this period only rallied16%. Had the disruption to South Africas supply happened when the auto industry was in fullswing, then the reaction would likely have been more severe. However, given the political

wrangling in South Africa, we feel supply disruptions are likely to become more frequent. TheMarikana mine episode may well turn out to be a wake-up call for the market in that ithighlights the social and political problems facing the precious metals industry in the regionand that is likely to underpin PGM prices. South Africa produces around 75% of the worldsmined Platinum output and accounted for 57% of total refined supply in 2011, when recycledmaterial is taken into account. Any disruptions therefore have potential to have a significantimpact on supply and prices.


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In 2008, power shortages in South Africa forced the industry to cut production and that sentprices to an all time high of $2,300/oz. In 2011, there were strikes as workers demanded payincreases and this, plus safety stoppages, are thought to have reduced output by some 300,000oz. This years disruptions were also started by demand for better pay and working conditions.Unfortunately it seems almost inevitable that there will be more disruptions to supply as thedisagreements between workers, the unions, the management and politicians are significant

and mining companies margins continue to be squeezed to the extent that they can not affordto buy cooperation. So whereas the market was expected to be in a supply surplus of around700,000 oz in 2012, lost production will have reduced the surplus, which in turn will meaninvestors have more chance of absorbing it. For 2013, as we feel there is a high chance offurther labour unrest and strikes as the power struggle rages between the National Union ofMineworkers (NUM), the new trade union - the Association of Mineworkers and ConstructionUnion (AMCU) and the ANC. With the ANC holding its general meeting to appoint the nextleader in December, the political situation could heat up again. The combination of disgruntledminers, safety stoppages, high costs and a strong rand, are all squeezing producers marginsand in turn that is impacting investment in the mining industry. All of which bodes ill for SouthAfrican output.

In Russia, output has generally been in decline; production peaked in 2001 at 1.3 Moz, but fellto a low of 785,000 oz in 2009. It recovered 5% in 2010, to 825,000 oz, according to data from

Johnson Matthey and was up 1.2 percent at 835,000 oz in 2011. This accounts for 9.8% of theWorlds refined supply. Output is now expected to decline as lower ore grades have an impacton output. Generally it is understood that Russias producers are investing to keep outputaround current levels, rather than looking to increase production, but they are also thought tobe processing stockpiled material to make up for the lower ore grades they are encountering.

North American production rebounded in 2011 following the ending of the long strike atVales Sudbury operations in 2010. The strike led to North American output dropping from anaverage of 330,000 oz between 2006 and 2008, to 260,000 oz in 2009 and 210,000 oz in 2010,before recovering to 350,000 tonnes in 2011. Output was hit again in 2012 as the companytemporarily shut down all eight mines in the Sudbury area to review safety procedures, whichmeant first quarter Platinum output dropped 33% to 38,000 ounces. In 2011, North Americaproduction accounted for 4.1% of global refined output.

Zimbabwes production has been climbing at a fast pace in recent years, from 165,000 oz in2006, to 280,000 oz in 2010 and 340,000 oz in 2011 - according to data from Johnson Matthey.

The country produces 4% of the worlds total supply including secondary supply from recycledmaterial. With further expansions underway, output is expected to continue increasing overthe past five years average annual growth has been around 21%. However, changes were madeto the law in early 2011, so now indigenous Zimbabweans must hold a majority ownership(51%) of all operations. This and other government intervention, such as the possible banning

of unprocessed Platinum exports and the raising of royalties, are likely to see foreigninvestment in the mining sector put on hold. With 51% local ownership there is also a questionas to whether sufficient money can be raised to fund ongoing investment in the industry. All inall, we would expect output growth to slow for a while.

Recycled MaterialSupply from recycled Platinum is a growth market at present as more and more of the vehiclesthat are reaching the end of their life-cycles now have autocatalysts. In addition, the worldsvehicle population has also taken off in the past ten years with the growth in sales in the


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emerging markets. Economic hardship, higher PGM prices and greater access to scrap-for-cashschemes have also led to more jewellery being sold for scrap. In addition, new legislation insome countries, which means electrical waste has to be recycled rather than sent to landfill, hasalso increased the amount of metal returning to the market. Between 2007 and 2011, supplyfrom scrap has grown at an average rate of around 7% per annum and in 2011, supply fromscrap accounted for 24% of total refined supply

Investment Demand Holds Up WellHoldings in the Platinum ETFs continue torise, they have been as high as 1.63 Moz,overcoming the 1.51 Moz peak from March2012 and the former peak at 1.50 Moz fromSeptember 2011. Not surprisingly, the latest

jump in ETF interest has been sparked by acombination of the labour unrest in SouthAfrica and the broad based QE that wasanticipated in August and seen in September.

With supply disruptions reducing thePlatinum supply surplus it seems investorsfeel more confident in holding Platinum andwe would say as the likelihood of furthersupply disruption are high, we feel investorswill remain generally bullish for the metal.Another reason for being bullish is thatPlatinum prices remain below those of Gold.Although the ratio has rebounded, judgingby where the ratio has come from there isconsiderable room for it to recover furthershould the fundamentals for Platinum turn

bullish see chart opposite.

With the ETFs now holding a large volume of metal, which is extremely liquid, the marketneeds to be aware that a heavy spell of redemptions could prompt a significant price sell-off.However, it will probably take concrete signs that the US is heading for another recession andthat China is having a hard landing, to trigger such a move. As the credit crisis unfolded in2008, holdings in the Platinum ETFs fell 50% from a peak of 483,796 oz in July, to a low of239,884 oz in late August. A similar move today would suggest 0.82 Moz of Platinum couldfind its way back on to the market. So although we are concerned about potential supplydisruptions in South Africa and we think the US and China will avoid hard landings - in thiseconomic climate where there is still a lot of uncertainty, we would be wary of taking too muchcomfort from the current situation even though ETF investors currently appear to be holding onfor the long term.

Funds Get Super BullishThe net long fund position (NLFP) started torace higher in mid-August and although themarkets were getting more bullish onaccount of expecting more quantitativeeasing, we feel the extent of the buying in


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Platinum shows the funds are bullish primarily on the back of the supply disruptions in SouthAfrica. Given the demand side profile for Platinum is not strong and is not expected to improvethat much in 2013, we feel there is a risk of liquidation selling if further supply disruptions arenot seen soon. The fact that the NLFP is so far above previous peaks suggests an overcrowdedtrade.

TechnicalThe recovery from the 2008 sell-off was very strong with prices bouncing from a low of$747/oz in October 2008, to $1,916/oz in August 2011 - a move of 157%. However, despiteputting in three extra peaks during 2011, none of them attracted follow-through buying andprices then started to correct. The pull back saw prices drop to $1,342/oz in December 2011,since then prices have zig-zagged sideways in a wide between $1,737/oz and $1,379/oz.Underlying support seems in place as the summer lows held above last Decembers lows, butoverhead supply between $1,737/oz and $1,916/oz seems effective. With prices now above the50 week moving average (WMA) we wait to see if prices will rechallenge overhead supplyagain. That said, with the stochastics falling, it looks more likely that prices will first need topull back in search of underlying support. We would expect the 50 WMA to provide support

and if a base can be built around that level then prices will be well placed to work away ateroding overhead supply. On balance we would look for trading to concentrate in the $1,500/ozto $1,750/oz range, with moves below there likely to find good support above $1,350/oz, whilemoves above $1,750/oz are likely to encounter resistance initially.

Conclusion and ForecastWe have become more bullish for Platinum recently as we feel the supply situation is lookingmore vulnerable as we expect labour unrest in South Africa to escalate in the year ahead. Welike the long term demand profile for the metal, although in the short term we feel the auto


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industry in Europe will remain a drag on demand and Platinum will not benefit the most from arecovery in auto sales in emerging markets, which we expect to be well underway later in2013. The auto market in North America is expected to remain a bright spot. The industrialside of the Platinum market may take a backseat in 2013 as the industry seems to have built upcapacity in recent years and we would now expect new capacity to be put on hold until thedemand outlook improves.

Platinum remains a metal with a good future, but it does need a sustained pick-up in economicgrowth to fuel industrial and auto demand. In recent years, investment interest has providedsolid growth and although investment interest dipped in 2011, the fact ETF holdings are nearrecord highs again, suggests investors remain committed to the metals medium term outlook.Indeed we feel the fact Platinum prices are below those of Gold is another bullish factor forinvestors.

In the short term, we expect prices to remain range bound between $1,400 and $1,700/oz as themarket adjusts to the price rally that got underway in mid-August. There is a risk that equitymarkets in the West might undergo a correction as they look over extended considering all theuncertainty in Europe and the potential for political wrangling in the US over the fiscal cliff.

If a correction ensues then we would expect metal prices to correct too. However, we wouldview such a move as another buying opportunity as long as it does not trigger another financialcrisis.

Generally if the EU can be stopped from imploding and the US avoids tripping over the fiscalcliff, then we feel there is room for optimism and that combined with the potential for supplydisruptions in South Africa would mean we remain friendly towards Platinum.

Overall, we feel Platinum prices will trade mainly in the $1,500/oz to $1,900/oz range over thenext twelve months or so. However, if the market were to move below $1,500/oz we wouldexpect the move to turn into a brief downward spike. On the upside we would only expectprices to hold above $1,900/oz if there were lasting supply disruptions.

Palladium

Palladium prices went into overdrive in the second half of 2010, with prices moving up overthe 2008 highs at $592/oz in October 2010 to reach $862/oz in February 2011. The run higherwas sparked by the recovery in the auto industry and on concerns that sales from Russianstockpiles would soon stop. The heat was taken out of the market by the earthquake andtsunami in Japan, as that dampened demand from the auto and electronics industries. Since the2011 peak, prices have held in a sideways to lower trading range, with resistance evidentbetween $700/oz and $725/oz, while buying has underpinned the market in the $535/oz to

$555/oz range. In 2012, prices have tended to oscillate in a broad range taking their cue fromchanges in sentiment in the auto industry as well as reacting to supply disruptions. The labourunrest in South Africa boosted prices, but strangely investors reaction to the disruption has notimpacted Palladium to nearly the same extent as Platinum. ETF investor holdings of Palladiumare still well below the highs, whereas Platinum holdings are at record highs. Demand from the

jewellery sector is also in decline as Palladium is losing market share to Platinum as Platinumprices are deemed relatively cheap now that they are below the Gold price. Palladium,however, continues to gain market share from Platinum in the auto industry given a $960/ozprice differential this trend is expected to continue.


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AutocatalystsThe auto industry is the largest user of Palladium, accounting for some 71% of demand. Therecovery in the auto industry in 2010 was a boom for Palladium as the industry consumed moremetal and at the same time restocked. Autocatalyst demand peaked in 2007 at 4.55 Moz, itdropped to 4.1 Moz in 2009, before rebounding 35% in 2010. Demand in 2011 reached 6 Moz,

according to Johnson Matthey, which was up a more subdued 8% compared with 2010, butgiven the general economic climate and the supply-chain disruptions in 2011, the increase wassurprisingly good. Demand is expected to remain robust in 2012, as the US auto marketcontinues to see a strong recovery, with sales expected to reach 14.3 million units this year andclimb to 15 million units in 2013. In addition, Chinese auto production in the first nine monthsof 2012, climbed around 5% according to data from the China Association of AutomobileManufacturers (CAAM). European car sales have been falling this year, they were down 7.6%in January to September 2012, compared with a year earlier and are expected to fall between8% and 10% for the year as a whole. European demand for Palladium used in autocatalystsaccounts for 23% of total autocatalyst demand, which somewhat cushions the impact that poorEuropean auto sales have on Palladium demand. The figure for sister metal Platinum is 47%.Out of total Palladium demand the breakdown of regional use by autocatalyst manufacturers is:

North America 17.5%, Europe 17%, China 13%, Japan 8%, RoW 16%, with 28.5% usedoutside the auto industry.

The medium term outlook for Palladium demand from the auto industry is quite mixed. Thestrongest market is likely to be the North American market where the recovery is expected tocontinue in 2013. Although growth in Chinese auto production picked up in the second quarterof 2012, the country has an over production problem and inventories of unsold cars haveclimbed in 2012 and that is likely to lead to manufacturers cutting back on the productionschedules. High fuels costs, more tolls, increased restrictions on ownership in some cities andslower economic growth are all impacting auto sales in China and these factors are expected toweigh on auto sales in the short to medium term. A pick-up in GDP growth again, shouldhowever see strong sales growth return. There is massive potential for demand for cars incentral and western parts of China to grow and with a car-ownership rate of 44 per 1000people, compared with a global average of 135 and a US average of 600, the long term outlookis second to none.

Indeed once this economic slowdown has run its course, Palladium demand is expected togrow significantly as the other BRIC countries are also likely to see a strong rebound in vehiclesales. As these countries have preference for petrol-driven vehicles, Palladium-based catalyticconvertors will be in high demand. Palladium is also making inroads into the diesel catalystconvertor market as Platinum-Palladium catalysts are now being used as opposed to Platinum-only convertors, boosting European demand for Palladium.

Demand for Palladium in emission control catalysts is expected to show growth of around 7%in 2012 and 2013.

Other Industrial UsesPalladiums other industrial uses include electronics, industrial manufacturing, glass and otheremission control equipment for factories and petrol-powered machinery, such as gardenequipment. The economic rebound in 2010, saw demand for Palladium from these industriesclimb 7%, but growth then slowed to 3% in 2011. The recovery after the 2008-2009 financialcrisis, led to a significant pick-up in industrial capacity that boosted demand for Palladium, but


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given slower economic growth in 2012 and a fairly subdued outlook for 2013, demand forextra capacity is likely to be low. As such, we feel demand from these industries will remainbelow par. In the 2008 to 2009 down turn, Palladium demand in these industries fell 12%, sogiven the likelihood of slow growth in the West then we should not be surprised if demand forPalladium from these industries is fairly flat to slightly higher.

Longer term, however, we expect strong demand growth from this sector as the high rate oftechnological change in the electrical equipment and computer industries, plus tighter emissionrestrictions for factories and petrol-powered machinery, should all lead to strong growth.Between 2004 and 2007, this sector saw average growth rates of 12% per annum, which wewould expect to see again once a sustainable recovery is underway - albeit probably not untilthe late 2013 at the earliest.

J ewellery DemandPalladium jewellery has had an interesting pastnine years or so. Demand took off in 2004 ashigher Platinum prices started to squeeze theprofit-margins of Platinum jewellery

manufacturers. Platinum jewellery has been aswing factor within the Platinum market foryears, so when prices started to climb above$850/oz in early 2004, demand for Platinum

jewellery started to fall and jewellerymanufacturers started to use Palladium, whichin early 2004 was trading around $200/oz. The potential profit margins meant demand soared.In 2003, some 250,000 oz of Palladium was used in the jewellery industry, it climbed to925,000 oz in 2004, 1,425,000 oz in 2005 and then averaged 1,025,000 oz between 2006 and2008. But as the chart shows, demand in China is now falling steadily and it remains to be seenwhether demand flattens out or continues to sink. Japans affinity for Palladium jewellery alsoseems to be fading - no doubt as Platinum prices have pulled back from their former peaks. Asfor the European and North American markets, the downturn in demand is probably more to dowith economic hardship than with changing tastes. Palladium has carved out a niche market asa metal for mens jewellery. There are a number of factors that have dented demand forPalladium jewellery in Asia. Firstly, because higher margins were built into the initial

jewellery price, when owners came to sell their jewellery they were disappointed by the resalevalue. Secondly, after seeing the rush of interest in 2005 and 2006, the drop in interest hasmeant stockists have had a bad experience with unsold stock and thirdly, limited marketing hasmeant Palladium jewellery is still seen in third place to Platinum and Gold jewellery. Demandfor Palladium jewellery is also suffering while Platinum prices are below those of Gold, asthere will be an extra incentive to buy Platinum jewellery as some will see it as being a goodinvestment. It will be interesting to see whether Palladium jewellery becomes more popular as

Palladium prices rise relative to Platinum, as it gains market share in the autocatalyst industry.

For 2012, we expect demand for Palladium from the jewellery industry to decline as the dips inPlatinum and Gold prices will have meant they have won back some market share. In 2013, weexpect higher Gold prices so it will be interesting to see if demand for Palladium jewellerypicks-up again as Gold jewellery gets more expensive. Longer term as Palladium prices closethe gap with Platinum, we expect interest in Palladium jewellery will recover.


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SUPPLY

Palladium supply comes from mine output (68%),recycled material (24%) and stockpile sales (8%).In 2011, Russia was the largest source of

Palladium; it mined 2.71 Moz and sold another 0.78Moz from stockpile, according to data from

Johnson Matthey. This compared with SouthAfricas mine output of 2.56 Moz. Supply fromrecycled material totalled 2.35 Moz, whileproduction from other countries totalled 1.32 Moz.

Up until recently, it looked as though South African production was growing and indeedcapacity-wise that remains the case, but production has over the past two years been affectedby strikes and safety stoppages and these seem set to continue. Other factors, such as risinglabour costs, lower prices and the strong rand have also squeezed producers margins, whichhave reduced the incentive to bring on more capacity.

Russias mine output had been trending lower, but this now seems to have stabilised, althoughsupply from Russia is falling as sales from stockpiles fall. Zimbabwe is a growth area forproduction - the country has considerable PGM reserves and is ramping up output. However,political issues surrounding ownership may well dampen investment in the mining sector. Soalthough we expect production to increase in 2012, production growth may slow thereafter.North American supply has recovered from the strikes in 2010/11, but production is nowexpected to flatten out as full capacity is achieved. Given the likelihood of further supplydisruptions in South Africa and declining stockpile sales from Russia, the onus is onZimbabwe to increase output. While we expect that to be seen in 2012, we would not want torely on that going forward.

Total mine production of Palladium in 2011 was around 6.58 Moz. On top of this, supply fromrecycled material was 2.35 Moz, giving a combined total of 8.93 Moz. This compared withgross demand of 8.45 Moz, leaving a supply surplus of 0.48 Moz. In addition, Russian salesfrom stockpiles were 0.78 Moz, which increased the overall surplus to 1.26 Moz.

In 2012, Palladium mine output is expected to fall 1% to 6.51 Moz and then by a further 1% in2013, to 6.45 Moz as we expect continued supply disruptions in South Africa.

Russian Sales From Stockpile Remain All ImportantThe question as to how long Russian stockpiles will last becomes ever more critical as eachyear passes as there must be a finite amount stockpiled. In the late 1990s and early 2000s,

export disruptions led to a significant increase in price volatility and that may well be on thecards again. Whereas in the past, the supply issues have revolved around export quotas, nowthe issue is likely to be more fundamental. Although the market expects lower stockpile salesgoing forward and that has to some extent been discounted in the market, we feel any concreteconfirmation that stockpile sales were to finish, would trigger a meaningful rally in Palladiumprices. In the current poor economic environment where demand has fallen and supply fromrecycled metal has grown strongly, the market could survive without stockpile sales, but themarket would no doubt notice the absence of the extra material in a more bullish environment.


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For 2013, we assume that sales from Russian stockpiles will continue, albeit at a slower rate,but we would remain alert for any signs that might suggest they are dwindling. Once thathappens, then Palladiums outlook is likely to become significantly more bullish.

Investment Demand Surprisingly WeakETF investors interest in Palladium

peaked in February 2011, at 2.37 Moz.This coincided with the $862/oz highin prices. Japans earthquake andtsunami followed and the negativeimpact that had on the auto industrydented investors appetite forPalladium. Although demand from theauto industry recovered as the secondquarter progressed, confidence in theprecious metals continued to suffer asthe EU debt situation weighed onsentiment. Holdings fell to 1.69 Moz in mid January 2012, but then started to recover as a

broad based rally got going in early 2012. This was again driven by fresh bouts of quantitativeeasing in the form of LTRO and as US vehicle demand remained robust. What is interestingthough, is that the ETF position in 2012 peaked at 2.10 Moz at the end of May, but has sincebeen drifting even the South African labour unrest has failed to fuel interest. This seemsstrange to us, but we feel investors see the unrest in South Africa as mainly impactingPlatinum, but the fact it affects 26% of total Palladium supply, is no small matter. Perhaps theother reason for investors weighting their bullishness towards Platinum is because Platinumprices are below those of Gold and therefore the metal is seen as having two bullish strings toits bow.

On balance, we would not be surprised to see ETF holdings rebound over the medium term, aswe feel the combination of likely supply disruptions and the potential for ongoing recovery inUS auto sales and later a recovery in Chinese auto sales, plus the likelihood of lower sales fromRussian stockpiles as being bullish for Palladium. If Russian stockpiles sales come to an endand demand rebounds then the metal held in the ETFs will be in demand to help fill the supplydeficit. When this time comes, investors are likely to demand ever increasing prices to releasethe metal they hold.

FundsThe net long fund position (NLFP) inPalladium has been erratic. There havebeen bouts of aggressive buying, which tiein with announcements of QE, with the

latest run up in the NLFP reacting to boththe broad based QE and the labour unrestin South Africa. What is interesting is thatoutside of these periods of bullishness, theNLFP had been trending lower. SinceFebruary 2011, the average NLFP hasequalled 8,980 contracts, between July2009 and February 2011, it averaged13,147 contracts. The early period


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represents the time when governments were running cash for clunkers programmes and whenQE seemed to have a long shelf-life, at least as far as investors were concerned, but in morerecent quarters, the deteriorating economic outlook brought about by slow growth in Europe(and the impact that has had on world growth) seems to dampened funds interest. Lookingforward we now feel the potential for strike action in South Africa will once again encouragefunds to hold a larger NLFP, especially given the potential for ever decreasing levels of

Russian stockpile sales.

TechnicalSince October 2011, Palladium prices have been trading sideways in a range between around$726/oz and $536/oz. Given this sideways range has followed the mega rally seen between2008 and 2010, that lifted prices 452%, it is unsurprising that prices have needed a long time toconsolidate. Given underlying tails around the lows it seems as though there is solid underlyingbuying interest around, conversely there seems to be selling above the $700/oz level. Judgingby the falling stochastic indicators it look as though the market is correcting following itsrecent run up to $705/oz and with prices back below the 50 week moving average a pull backto the long term up trend line at around $577/oz would not be too surprising, We would,however, expect solid support between the bottom of the triangle ($560/oz) and the October

2011 lows (536.50/oz). On balance we feel prices will continue to range trade, but while theydo so if they continue to build higher bases then pressure is likely to build up beneath the topof the triangle at around $690/oz and the two previous peaks at $705/oz and $725/oz. Overallwe feel Palladium prices are consolidating in a continuation pattern that will eventually lead toan upside break.

Conclusion and ForecastOut of all the PGMs we are most bullish for Palladium over the long run. Palladium has a priceadvantage over Platinum and while that remains the case it means Palladium has potential to


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win market share from Platinum in the autocatalyst market and to some extent in the jewellerymarket. However, Palladiums supply fundamentals also look bullish. Although supplydisruptions would affect a greater share of Platinum supply than it would Palladiums, it wouldstill disrupt a meaningful amount of Palladium. However, Palladium supply is also likely to fallas sales from Russian stockpiles decline. Reports suggest that these stockpile sales are likely todry up over the next few years. Although these sales may not be needed during this slower

economic period, they are likely to be missed once demand for Palladium recovers.

Palladium also has the advantage of being the main PGM used in petrol-driven vehicles, whichhappen to be prevalent in Asia and the US. Asia is likely to remain the strongest regionalmarket for organic vehicle growth. On balance we feel Palladiums demand set-up ispotentially more bullish than that of.

However, in the short term given lacklustre auto and industrial demand in Asia and Europe, wefeel prices are trading sideways as they wait for stronger economic times. For now, the USseems to be seeing good auto sales growth, but the market is nervous whether that willcontinue given the US faces a fiscal cliff at the start of 2013. In addition, although Europeseems out of immediate danger following the ECBs willingness to buy unlimited bonds, the

risk of another crisis unfolding has not gone away.

Assuming that another crisis in Europe does not escalate and the US manages to avoidtriggering the fiscal cliff then we feel China is well placed to see stronger growth unfold as2013 progresses and that should underpin global business confidence. In turn that should keepinvestors interested in Palladium, which should support a slightly bullish bias for prices.Overall we would look for range trading between $550/oz and $725/oz, but would not besurprised to see prices move up into the higher range that runs up towards $850/oz should therebe further supply disruptions in South Africa.

Rhodium Outlook

Rhodium prices remain weak and are waitingfor a recovery in demand. The market is in asupply surplus, production has been rising as toohas supply from recycled material. Since 2007,when the market was last in a supply deficit,each year has seen a surplus the cumulativestock build during this period is thought to bearound the 500,000 oz mark. Needless to say,

consumers are thought to be running on a hand-to-mouth basis and given the price performancethat is not surprising. However, what isnoteworthy is that there are reports that some industry users, who are looking to build morecapacity in the years ahead, have been stockpiling Rhodium for use down the road. Thissuggests they see these prices as cheap. Indeed, given where prices have come from (see chart)and given the likelihood that restocking lies ahead at some stage, we do feel the downside islimited. It will be interesting to monitor the Rhodium ETF to see when investor interest startsto anticipate a recovery.


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Between 2004 and 2007, Rhodium was in a supply deficit, with the balance made up frominventory and from recycled metal. In 2008, the market showed a supply surplus of 25,000 ozand this leapt to 241,000 oz in 2009 as supply recovered in South Africa after the power relatedshortages in 2008 and industrial demand slumped 20%. However, the rebound in the autoindustry in 2010, saw the surplus shrink to 88,000 oz and then slower economic activity and a

pick-up in mine and recycled supply saw the surplus rise to 139,000 oz in 2011- according todata from Johnson Matthey.

DEMAND

Rhodium demand is predominantly focused on the autocatalyst market, which in 2007 (i.e.before the economic slowdown) absorbed around 85% of supply and the glass and industrialmanufacturing industries both accounted for around 6% of global demand. Generally, demandfrom these industries is price inelastic, but what is noticeable in the glass industry is that it goesthrough phases of building new capacity, which is then followed by less demand until morecapacity is once again needed. In recent years demand for flat screens has been strong mainlyas new technology has produced products that have been highly sought after even though

economic times have been difficult. Smart phones and tablet computers use more glass peritem than earlier generations of mobile phones and new television technology has also boosteddemand for larger screens. However, demand for televisions has weakened in 2012, so thissector of the industry is likely to suffer, although we still expect strong growth from the mobiletechnology sector. That said, having ramped up capacity in recent years, we would now expectdemand from this industry to be quieter in 2013.

All in all, we expect Rhodium demand to follow the trends in economic activity, with specialregard to the auto industry. The outlook for the auto industry is mixed, demand is fairly strongin North America, but has been relatively weak in China and the other BRIC countries. We do,however, expect growth in China to stabilise and then recover as 2013 unfolds, which in turnshould mean the worlds two largest auto markets are positive factors for Rhodium demandnext year. We also expect that once China starts to see stronger growth, other BRIC countrieswill follow suit.

Investment InterestThe launch of the Rhodium ETF in June 2011 has provided another potential area of demandfor the metal and we would expect investment interest to gather pace once a brighter economicoutlook appears. At the end of 2011, the ETF held 17,000 oz. By the end of the first quarterthis had climbed to 23,500 oz and in October stood at around 50,000 oz. As such, investorsseem to be accumulating Rhodium while prices are relatively low.

Supply

Rhodium supply peaked in 2007 at 824,000 oz, but then was hit heavily by the power outagesin South Africa in 2008 that saw global production drop to 695,000 oz - according to JohnsonMatthey data. In 2011, production had recovered to 765,000 oz, with South Africas share ofglobal mine output back at 84%. In 2011, output in South Africa and Russia was still below thelevels seen in 2007 while the main growth area has been in Zimbabwe, where output hasclimbed to 29,000 oz from 14,000 oz in 2007.

In 2012, labour unrest in South Africa has seen PGM supply fall and that in turn is expected tosee less Rhodium produced. Looking forward, given our concerns about labour unrest in South


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This report has been prepared on behalf of ScotiaMocatta and is not for the use of private individuals.

TMTrademarks of The Bank of Nova Scotia. Used under license, where applicable. Scotiabank, together withGlobal Banking and Markets, is a marketing name for the global corporate and investment banking and capitalmarkets businesses of The Bank of Nova Scotia and certain of its affiliates in the countries where they operate.The ScotiaMocatta trademark is used in association with the precious and base metals businesses of The Bank ofNova Scotia. The Bank of Nova Scotia, a Canadian chartered bank, is incorporated in Canada with limited

liability.Opinions, estimates and projections contained herein are subject to change without notice. The information andopinions contained herein have been compiled or arrived at fromsources believed reliable but no representationor warranty, express or implied, is made as to their accuracy or completeness. Neither The Bank of Nova Scotia,its affiliates, employees or agents accepts any liability whatsoever for any loss arising fromthe use of this reportor its contents. The Bank of Nova Scotia, its affiliates, employees or agents may hold a position in the productscontained herein. This report is not a direct offer financial promotion, and is not to be construed as, an offer tosell or solicitation of an offer to buy any products whatsoever.

This market commentary is regarded as a marketing communication. It has not been prepared in accordancewith legal requirements designed to promote the independence of investment research and is not subject to anyprohibition on dealing ahead of the dissemination of investment research.

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