Platinum deficit and South Africa crisis: asymmetric investment idea
Mihail Stoyanov
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South Africa. A country is as remarkable as it is troubling. Discovered by the Portuguese, colonized by the Dutch, and conquered by the British. Gained independence from the British Empire in 1931.
The country passed through turbulent years of apartheid, beginning in 1948. With its end, a new era in South African history began. South Africa had a period of economic growth and integration into the global world. The peak of the integration was South Africa's hosting of the World Cup in 2010 and membership of BRICS in 2011.
At the same time, South Africa is torn by deep problems - extreme inequality, economic stagnation, and high crime rates. Wealth has been concentrated in the hands of the descendants of English and Dutch settlers, while the levers of power for the past 29 years have been in the hands of the African National Congress (ANC). This is Nelson Mandela's party, representing the interests of the country's natives, who are 80% of the total population. Ethnic and political differences between South Africa's ruling and economic elites deepen the crisis.
The author visited Cape Town several times between 2012 and 2018. Even then, the looming problems were visible. However, they have worsened considerably over the past few years - constant power cuts, an intense racial division, and a shrinking economy.
South Africa remains the most developed country in sub-Saharan Africa and a significant player in diamond, gold, and platinum group metals (PGMs) mining. The latter, in turn, plays a crucial role in the energy transition. And like most commodities, they, too, suffer from a supply-demand imbalance.
The synergy between the growing deficit of PGMs, South Africa's central role in their extraction, and the chronic state crisis brings asymmetric investment opportunities. The approach that exploits such opportunities is event-driven-driven macro (EDM). It is the intersection of macroeconomics, geopolitics, and catalytic events.
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Crisis in South Africa + platinum deficit = Event-driven macro opportunity
Transitioning to clean energy requires a mind-boggling amount of commodities. One of them is platinum. And South Africa produces over 70% of the world's output. At the same time, South Africa suffers from chronic problems.
The demand side and the catalyst are familiar - the energy transition and the crisis in South Africa. I will examine the supply and demand in detail.
The platinum market - supply, demand, and deficit
Platinum is among the critical metals for the transition to clean energy. Like most of the commodities, its CAPEX cycle has bottomed already. The imbalance between supply and demand has begun to materialize. For 2023, the deficit is 983 thousand ounces.
The following graph illustrates the growing deficit:
The deficit will continue to increase. The question is how much and for how long. So far, the forecasts are diverging from reality. According to the chart above, from February 2022, a deficit of 650 thousand ounces is expected for 2023. However, the shortfall is 50% more than projected at 983 thousand ounces. It is expected to reach 1900 ounces in 2030, about 30% of annual platinum production.
Demand
The demand for PGMs is linked to air emissions control. Over 60% of the annual production goes to catalytic converters:
In recent years, a low-cost alternative to PGMs for catalysts has been researched, and silver has led the way. Time will tell whether it or another metal will prove to be a suitable replacement.
At the same time, the production of cars with internal combustion engines is gradually declining, which also affects the demand for PGMs for catalytic converters. However, despite the declining demand for catalyst production, demand for PGMs will continue to grow:
Setting zero carbon targets requires measures that go beyond catalysts. Fuel cells powering cars are becoming increasingly relevant. The role of platinum in the cells is that of a catalyst, which accelerates the chemical processes taking place.
In fuel cells, however, there is (so far) no alternative to replace platinum. For fuel cells alone, the market is expected to reach 10% of the total after 2030 and 28% by 2040. These dates seem very far away in time. However, in the context of contracting supply, they are close.
Supply
The uranium mining industry is dominated by four countries - Kazakhstan, Namibia, Australia, Canada, and Russia. In PGMs, however, supply is even more concentrated—the leading player in South Africa and, to some extent, Russia (in palladium only).
Like all other metal mining industries, this one follows the CAPEX cycle flawlessly. The lack of capital investments over the past decade has started to bear fruit. Supply is shrinking, and the need for discoveries to replenish the depleted reserves is urgent. The basic heuristic in the mining industry is as follows:
The reserve renewal rate should be higher than the reserve depletion rate.
The following chart illustrates the steady decline in reserves of one of the major platinum mining companies:
With constant annual production, Impala Platinum reserves will deplete at a higher rate after 2025.
The reserves (blue) are part of the resource base (yellow and green). They are proven to be in the ground and can be extracted, but it is still being determined to what extent and at what cost it is viable for their extraction. Converting resources into reserves requires time and capital. And in recent years, there has been little investment.
The chart presented is not the exception but the rule for mines producing PGMs. In the coming years, the reserves will reach its peak.
Over the last year, the big players in the industry have increased their investments, but this does not mean that new mines will come out tomorrow. For the foreseeable future, the resource depletion rate will remain higher than the resource renewal rate.
Apart from the time to discover, develop, and build a new mine, the location of these deposits is a crucial factor. For every 100 ounces of platinum reserves, 90 are in South Africa, six are in Russia, and two are in Europe. The remaining two ounces are in North and Latin America.
South Africa is in an acute crisis, and Russia is partially isolated politically and economically. These two factors make discovering new deposits and building mines even more challenging.
Recycling temporarily quells platinum deficiency problems. Here's what the platinum supply side looks like for 2022:
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Out of every four ounces of platinum, one comes through recycling. But even that cannot compensate for one country dominating the platinum supply. The statistics clearly show it:
All platinum mines are located in the northeast of the country. And in this part of South Africa, the electricity grid needs to be updated and maintained. The map below shows the location of mineral deposits in South Africa, including platinum:
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In the context of the current crisis, the power grid in the region is old and has to be renewed. I expect the situation to worsen - power cuts and worker strikes will become more frequent. They significantly threaten the efficiency of operations in South Africa's mines.
ESCOM, South Africa's national power company, has moved to a Level 6 power regime - 36 hours without power every 96 hours. This removes about 6000 megawatts from the grid.
ESCOM has been technically bankrupt for over a year. Traditionally, South African state-owned enterprises are run by corrupt and incompetent officials—a classic combination proved incapable of creating value.
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Conclusion
The growing imbalance between supply and demand will affect platinum prices in the long term. However, the looming problems in South Africa have the potential to be the spark that will cause a parabolic price action.
2008, increased demand for PGMs to produce catalytic converters and a shock contraction in platinum supply due to the power outages. The price of platinum and palladium reached record levels.
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Earlier, I compared uranium mining and?PGM miners. Both markets experience deepening deficits.
However, while uranium supply is affected only by the lack of investment in PGMs, the crisis in South Africa plays a significant role. Its deepening will affect platinum production, and the question is not if but when and by how badly.
In summary:
The turmoil in South Africa significantly raises the risk of a supply contraction over the next 12 months.
Like any forecast about the future, this one has its weaknesses. Two of them carry the most weight:
·??????South Africa's rulers find a resolution to the crisis - a possible but unlikely scenario. Many structural weaknesses in the country's governance have become apparent in recent years. They are symptoms of deep and intractable problems. The latter requires a radical change in the thinking of South Africa's financial and political elite. Such changes are complex and take time. In my view, even if a solution is found, it will be temporary and only quell the symptoms. At most, it will postpone the escalation of the crisis, but it will not reverse it.
·??????Finding a substitute for platinum - for many years, research has been underway to find cheap alternatives to PGMs. However, this is not an easy task because the properties of these metals are unique and very difficult to replicate at a low cost. Gold and palladium are not a solution because their price is often higher than platinum. So far, silver is owned as the substitute with the highest potential. However, even if it proves to be a workable alternative, it will be several years before its introduction.
The latter has more potential to invalidate my hypothesis. Long-term sustainable resolution of the crisis in South Africa is possible but unlikely.
The trend more often keeps its direction than changing it. This fundamental principle in technical analysis applies with full force to all complex processes, including political-economic crises such as the one currently raging in South Africa.
The introduction of a substitute for platinum is a scenario with higher credibility. However, it will take years, during which the deficit will continue to grow. The growing platinum deficiency is not an isolated case. It is a fact in all metals to varying degrees.
From an investment point of view, platinum and PGMs provide investors with an analytical edge - the production is concentrated in one country. This makes predicting supply issues easier than aluminum or nickel, where a few countries dominate the market.
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How could you take advantage of this opportunity?
One metal, one country, and deep crisis - an event-driven macro idea in one line. EDM is among my favorite strategies because it provides asymmetric bets and a time frame.
The platinum shortage and the crisis in South Africa are great examples. However, how do you take advantage of the situation? We have various instruments at our disposal - derivatives, equities, ETFs, and everything else. Each of the above has pros and cons.
Investments in platinum mining companies have one serious drawback - they are all based in South Africa, as 90% of platinum reserves are located there. This means we cannot easily mitigate country-specific risk. There is only one exception: Zimplats, which operates only in Zimbabwe.
Even a concentrated industry like uranium mining offers alternatives - Canada, Australia, Namibia, and Kazakhstan. With platinum, we do not have options.
The only companies focused on platinum mining are in South Africa and Russia. Some major mining companies extract platinum as a by-product of polymetallic mines. Examples are BHP, Vale, and Glencore. In their case, platinum mining accounts for less than 3% of total revenues. And as few ounces as that is, much of it again comes from South African mines.
Compared to the platinum mining industry, the uranium mining industry seems incredibly diversified.
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The world is vast, and Alpha is lurking everywhere. In today's article, I showed you how I put this motto into practice through the Event-driven macro strategy.
It combines two ingredients - top-down analysis and the presence of a catalytic event. The process starts with the big picture in search of global shifts. Then, it examines how and where these changes will cause profound consequences. Eventually, I isolate regions and industries that will benefit from these changes.
The final ingredient is the catalytic event, which will crucially impact the region and industry when it occurs. Furthermore, it sets the time frame of my investment hypothesis, i.e., its timing.
The mining sector offers one of the best EDM opportunities. We can forecast the future supply with relatively high credibility. This is especially true for raw materials whose extraction is concentrated in a few countries. Platinum and uranium are such examples. ?