The Capital Cycle Podcast - Platinum Bombed

Episode Date: May 30, 2025

Investors appear highly pessimistic about the value of Platinum Group Metals. They may be wrong. Edward Chancellor talks to Alex Duffy, an Emerging Markets Portfolio Manager.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello and welcome to another episode of the Capital Cycle podcast. This is Edward Chancellor here with Alex Duffy, who's an emerging markets portfolio manager with marathon asset management. Nice to see you, Alex. Good to see you again, Edward. Thanks for having me on. So we're going to talk today about your views that the mining companies that extract so-called platinum group metals, platinum palladium and rhodium, appear to be an attractive inventing. investment at current share prices. But before we go down that particular rabbit hole, let's discuss your thoughts on how investors crave for certainty or what we sometimes call comfort in the investment world and how that creates opportunities for contrarian stock pickers. So as an introduction,

we find the Platinum Group metals sector interesting from an investment perspective because it's an area which is going through supply consolidation, which we're going to discuss in a moment or two. But actually, the opportunity is presenting itself by depressed prices because of heightened uncertainty around demand expectations. And so that's led to both commodity prices to decline substantially, but also other investors to neglect the space because it's sort of too difficult to analyze. There are lots of moving parts on the demand side, not so on the supply side, but lots of moving parts on the demand side, which make for a very uncertain outlook. And actually, on reflection, if one looks at the drivers of returns in equity markets

over the last few years, markets have increasingly been driven by a narrower subset of companies where investors' belief in the sustainability and certainty of those business models has reached levels where it's impossible to think of any other outcome. So, Alex, so I think what you're really talking about is the heightened investor interest in not just the magnificent seven, the small number of US mega cap growth stocks, but also interest in quality companies in general, companies that have higher and sustained returns on capital, companies that tend to have relatively little debt, companies whose share prices on the whole are relatively stable, relative to the market. That's the sort of thing you're thinking of. Yeah, and fundamental factors such as that which are not to be ignored, you know, they have underlying merits. It's when those fundamental factors are set alongside ever-growing valuations that heightened risk is sort of bought into. So in the search for certainty, investors bid up

those stock prices. And actually what you end up with is a scenario where any other outcome, rather than the status quo can create a material drawdown in equity values, either because of a multiple de-rating from a valuation perspective or potentially because the earnings outlook isn't as rosy as one might have thought. And so when the state of the world changes from a demand perspective or a global perspective, as one could argue we may be going through now, what investors felt was certain suddenly becomes very uncertain. And it's in those areas that investment risk presents itself.

And so we like to sort of position ourselves on the other side of that, Edward. Yeah. So some of the listeners will be familiar with Hyman Minsky's financial instability hypothesis, where more stability gives way to instability. And now we have Duffy's certainty instability hypothesis, where the more certainty there is in the market, the more valuation risk builds up, eventually creating a position of uncertainty.

After that throat clearing, let's get on to the platinum group metals. You think that this is an attractive opportunity. First of all, will you define this group? Yeah, so platinum group metals is a relatively niche part of the resources sector, probably less well known to many, but ultimately critical to all of our daily lives. They consist of three major commodities within the group, platinum, palladium, rhodium, and the mining companies also extract a small amount of gold alongside that. They have a variety of uses, but primarily, particularly in the case of palladium,

they go into the catalytic converters, which are attached to combustion engines to remove all of the harmful and toxic emissions. And so they're absolutely fundamentally important to clean cities and, as I said, to remove in harmful NOx emissions. from all of our vehicles that we drive on a daily basis. And platinum and palladium have particular industrial uses because of their capacity to withstand extremely high temperatures. Is that correct? That's correct.

They've got unique properties that make them very effective catalysts to solve the problem of emissions from engines. And whilst they're interchangeable, so you could use palladium over platinum or vice versa, thus far there's been no alternative outside of the PGM group that serves the same purpose in the catalyst. And they are very rare, or at least I read that platinum in terms of mining is 20 times rarer than gold. It's also, along with palladium, an official monetary metal, but we're not going to discuss that. But what is it, the XAU is gold, and then aren't platinum and platoom also have an

X in front of their names. XPD and XPT. So yes, platinum has, I think, more potential monetary value. Obviously, a lot of people will be familiar with it as a source of jewelry demand, which is 20% of platinum's overall demand. So it does have those sorts of properties, but predominantly these are industrial metals as opposed to monetary instruments. So let's get into the reason why you've taken a position in these stocks. Now, first of all, they've been in the doldrums. and you've decided to become a buyer at current levels. I think it's worth bearing in mind some of the characteristics of these metals. First of all, they're very concentrated in terms of their geographic supply.

So 80% of the world's platinum is mined within South Africa. Palladium is sourced 45% from South Africa, but otherwise from Russia and a small amount from North America. the sector exhibited a period from around 2020 to 2022, whereas a consequence of COVID supply disruptions and then inventory stocking by the auto EMS, there was quite a powerful up cycle, albeit short-lived. And that's been followed by a significant price decline

and significant decline in market valuations for the companies to the point where today, around, 30% of the industry is loss-making on a cash basis. So prices have fallen to the point where it's no longer economic for a significant part of the industry to produce. And those price declines have been met with significant declines in stock prices where the industry has lost around 80% of its market capitalisation over the last couple of years. Now let's discuss the nature of the Platon Group mining industry from a capital cycle perspective. Yeah. So for the most part, like with other mining industries, PGMs exposed to quite long cycles. And so other than the short-lived

period 2020 to 2022, the last major up cycle occurred around 2006 to 2008. And as a consequence of the fact that they're high fixed cost in nature, they're very capital intensive. What is required to bring on new supply is a period of elevated prices that incentivizes investment into the sector. And equally, what is required to reduce supply in the industry is an extended period of depressed pricing. And what we've found as a consequence of a very painful bear market for the metals from around 2012 up until 2020

is a high degree of underinvestment that we feel is now setting us up for a period of supply disruption and supply declines that should ultimately result in in a recovery in industry fundamentals, as the solution to low prices is always low prices. And you show in your piece the capex to depreciation ratio for the industry declining.

Yeah. So I think this is, you know, one of the key metrics that we look at from a capital cycle perspective is really how is an industry investing to sustain its current level of output or not. And when you look at the capital investment, so the capex spending by mining companies in the PGM industry, what we see is that in eight of the last 10 years, capex spending has been below the level required to sustain current output. It's worth mentioning that through that same period, mining costs have increased by about 6% per annum, but capex costs have also increased by a similar amount, and yet nominal capex levels are broadly flat. So there's been a

significant decrease in the real amount of capital that's being invested back into the industry. I see. So what you're saying, Alex, is that the reported cap extra depreciation ratio actually understates the degree of underinvestment because they're working off of historic prices. Absolutely. That's absolutely right. And you believe this is now constraining supply and that the market for platinum group metals is now falling into a position of chronic under supply. Yeah. So there's two major sources. really of PGM supply. There's the primary supply that comes from the mines themselves, and then there's secondary supply which comes through recycling. If we deal with primary supply in the first

instance, what we've seen is mines increasingly struggle to maintain existing output, and actually over the last few years, the South African mines, which as I mentioned earlier, account for around 80% of overall platinum output, the South African mines have seen reasonably significant declines in output. And that is expected to decrease by a further 10 to 15% over the next five years as a consequence of the level of underinvestment that we're witnessing. And so whilst there might be questions and high uncertainty around demand on the supply side, there is actually a high level of certainty as to what the future looks like. And it's one. of increasing tightness in terms of, you know, mine's ability to respond and reduce metal.

So one of the tenets of the capital cycle investment philosophies is that companies become reluctant to invest when the market value of their assets fall below replacement cost, at which point it makes sense to return capital to shareholders, buy back shares or whatever, but not to invest in new capacity. How does this affect the Patom Group metal miners? There's two ways that that gets impacted. In the first instance, mines are not investing enough to sustain current output. But as you point out, with replacement costs, which depending upon the estimates that one looks at, appear to be around two to three times above current market levels, companies are not incentivised to replace and add new capacity in the industry. So we've got this

double problem, if you like, where existing mines are being underinvested, which stores up the problems for future supply, and then new discoveries are not being made to add replacement ounces once existing minds come to the end of their life, which is becoming increasingly likely as we look over the next two, three, five years and beyond. And so I think there are two elements. One is existing minds will disappoint because they're being underinvested and supply risk is increased as a consequence of that. But equally, once existing minds reach end of life, there is nothing to replace them. That is a direct result of management teams responding to low valuations and the market signal, which is saying do not invest back into these assets because

we won't reward you for the answers which you might produce in the future. But Alex, in your piece, you also say that individual industry players are reluctant to cut capacity, partly because they don't want to be the company that by cutting capacity restores price discipline for the rest of the industry at their cost. So I was watching something about gold mining the other day. In the gold mining industry, they say mines die hard. In other words, unprofitable mines take a long time to come out of production. So that's some concern of yours here, is that correct?

Inevitably, within a mining company's portfolio, there's not just one single asset. The industry is consolidated to a level where there's broadly four main producers that operate a variety of different mines within their portfolio. And there is a cross-subsidy of profitable mines versus loss-making minds within that. And so whilst prices have cut into the cost curve, and certain assets within a particular company's portfolio may be loss-making, as a consequence of the game theory of the industry, the issues around the politics of closing mines and laying off workers,

the companies themselves are reluctant to close individual assets. And so the way in which this supply response will present itself, we believe, is as a consequence of the underinvestment, which just means that at a certain point in time, all of the assets are at risk of disappointing. So what often happens when you're mining platinum, which comes from an underground mine, I should point out as well, is that there will be something that happens

with the geology, which reduces output inadvertently. And so what we're actually exposed to is not supply being taken offline deliberately. It's inadvertent production misses, which we've already witnessed over the last few months, that can have a significant impact on the supply demand dynamics within the industry. And so we think that is where this supply response presents itself, not through necessarily deliberate actions from an individual company. So, Alex, to be clear here, you think that if there are supply problems or production problems at individual mines as part of the larger groups, that will feed through to shortage of supply, which will feed through to higher prices for platinum group metals. It mustn't lose sight of the fact that we operate in a financial world, but this is a very physical commodity and it gets produced to be used in its demand case.

and the actual fundamental markets are quite tight. If you look at the amount of platinum that's used annually versus the amount that's supplied, it's always in a reasonably tight balance. And so a 2 to 3% supply miss puts the market into a deficit. And if the customers can't find those metal ounces elsewhere, they'll be forced to go into the spot market to buy them at higher prices, or they'll be forced to bid up prices for their use case, which creates demand destruction somewhere else within the industry supply chain. And so there is an immediate impact on prices of physical supply disruptions, and it's that which we feel will restore PGM prices to higher levels. You mentioned an extra supply of the platinum group metals from

recycling and you wrote about that in your piece. Just talk about that source of supply. So the recycling sector accounts for approximately 20 to 25% of supply in the industry, depending upon which of the metals you look at. So that is where the average useful life of a vehicle of a car would be around 8 to 10 years, depending on the market you look at. So after that, the vehicle gets scrapped through the scrapping process, PGM metals which sit within the catalytic converter are extracted and then reprocessed. And so you can actually track secondary supply, as we call it, by following the scrapping cycle and the historic demand within the industry. And that has obviously grown over time because

PGM loadings went up significantly. We tightened an emission standards around a decade or so ago. The point we've reached now, however, is that whilst 30% of mine, are loss-making, it's actually uneconomic to recycle PGM metals from catalytic converters because there's only two grams of metal, which is valued at around $100 within each of the catalytic converters. And obviously, there is a labour cost, there's a processing cost, and there's an inventory financing cost in the recycling process. And so what we found is that whilst there were very strong projections about supply growth from recycling, that is also disappointing as a consequence of the price environment, but also as a consequence of vehicles being driven

longer, which means that that metal is staying in the existing fleet of cars for longer than was originally anticipated. So I think that's actually quite a material tightening on the supply side alongside the underinvestment in primary supplier that we've just discussed. So, Alex, a sceptic to your viewpoint would say that the long-term, demand outlook for platinum group metals is set to decline as battery electric vehicles take ever-increasing market share and the internal combustion engine goes the way of the dodo or at least the horse-drawn carriage. What do you say to that? The point's absolutely valid. We've seen in China, for instance, the increase in EVs, which are now over a third of the annual sales

of vehicles and electric vehicles don't have the need for a catalytic converter. You know, that's an important source of demand, particularly for palladium that has started to decline. But in other markets, EV penetration is much slower than projections. And so it comes back to this point around certainty and uncertainty. There was almost unequivocal certainty that EVs would take over the world and PGM metals would not be required. But actually, that's far less certain today than it was a few years ago. Well, I mean, no, hang on saying, let's not call it certain a few years ago. We can say that the demand forecasts were overly confident.

And that is a principle of the capital cycle philosophy is that we see demand forecasts the whole time, which don't actually eventuate as people expect. Absolutely. So I think there's still an argument to be made and a valid argument that EV penetration will likely increase globally over time. However, the rate of income. increase is significantly lower than initial sort of expectations in the US and in Europe. EVs are still expensive. Internal combustion engine sales have been growing year on year in absolute

terms, not shrinking. And so I think, you know, that's an important point that we shouldn't miss out on. And ultimately, there are other sources. So hybrid vehicles still have ICE engines attached to them that require a PGM loading. And then there are other uses, heavy-duty trucks, for instance, where emission standards tighten year on year. And that requires more PGM per catalytic converter. And so, you know, whilst EV takes the headlines, there are lots of other drivers on the demand side, which, you know, create a degree of uncertainty as to the rate of demand

destruction and demand decline. And actually, what is becoming increasingly obvious to us is that the supply side is absolutely under constrained. And we can absolutely constrained. And we can observe that through the actions of companies. We can observe that through the capital cycle that those management teams are facing. And that gives us an increased degree of conviction in the supply side relative to that demand argument, which has prevailed over the last few years. And it's within that intersection that we actually find the opportunity.

Now, last word, Alex, you write that you think the best approach to investing in these platinum group metal miners is broad brush, namely purchasing a basket of stocks. Can you explain that? Yeah, again, quite contrary to the fashion for highly concentrated portfolios, what we're dealing with here is an industry-wide event where every company is underinvesting in their own capacity. As a consequence of supply disruptions being inadvertent rather than deliberate, it's quite difficult to see where the supply outage will come from at the company level. We're just quite confident that it is going to occur at an industry level. And therefore, the supply disruptions are beneficial to all producers of the metal. And yet one of the companies, which has a particularly bad outcome from a supply perspective, might be quite severely disadvantaged. but it's just very difficult to say with any degree of certainty which company that will be. And so as a consequence of that element of uncertainty again,

we think merits a diversified approach to invest in within this subset of a capital cycle rather than a sort of very singular position around the kind of, you know, the cost of carry argument. Well, that sounds a sensible approach, Alex, and it's been good talking to you and good luck with this investment. Thanks for your time as always. Thank you for your time today. I hope you will listen to the next edition of the Capital Cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.