This Miner Is Set To Profit From One Of The Rarest Metals On Earth
Metals and mining stocks have taken a hit over the past year as global growth slowed and commodity prices plummeted. The SPDR S&P Metals and Mining ETF (NYSE: XME) lost 27% in 2014 and has retreated another 8.5% so far this year.
Yet, one metal has bucked the trend, and a three-year supply deficit looks set to continue in 2015 and beyond. Russia accounts for 41% of global production of this rare metal, but reserves in the country are “pretty much exhausted,” according to one of the largest corporate users.
As you can see below, palladium held up as other metals like copper and platinum plunged last year.
As palladium gets more precious and prices defy market forces weighing on other metals, one company stands to benefit as a major producer and recycler.
A Tight Market Could Get Tighter
#-ad_banner-#Roughly three-quarters of palladium demand goes to the automobile sector. It is used in catalytic converters, which reduce emissions. With the steep drop in gasoline prices, analysts are expecting continued strength in car sales. This, combined with a growing number of vehicles in China, could increase global palladium demand.
Johnson Matthey plc, a London-based company that makes a third of the world’s catalytic converters, estimated that supply lagged demand by 915,000 ounces in 2012. That supply deficit grew to 1.2 million ounces last year and will be 907,000 this year, according to Deutsche Bank (NYSE: DB), which sees production deficits continuing for at least the next five years.
Inventories of the metal have been falling to cover the deficit and may be close to tapped out.
Both Russia and South Africa, which combined account for 78% of global production, have seen significant supply disruptions over the past several years. This means that mining in other countries and recycling will need to pick up the pace or prices could head much higher.
Morgan Stanley (NYSE: MS) estimates that palladium prices will average $881 per ounce this year, about 15% above their current price. This could set the stage for the substitution of platinum in catalytic converters. Platinum prices have been increasing recently, and the gap between the two metals has closed.
While the outlook is still good for palladium prices, even if platinum steals some demand, there is one company that will benefit whichever metal wins out.
Stillwater Mining (NYSE: SWC) is the leading low-cost platinum group metals (PGMs) producer in North America and the only U.S. producer. The miner’s reserves are split between palladium (80%) and platinum (20%) with up to 40 years of proven and probable reserves.
In 2013, the company produced 524,000 ounces of PGM and processed 617,000 ounces at its recycling plants. The recycling segment has become a significant contributor with a 230% increase in revenue and a 54% volume increase in the three years to 2013.
Management has set guidance for all-in sustaining costs (AISC) of between $780 and $830 per ounce with the most recent reported figure of $805, well under the company’s average realized price of around $1,000 per ounce for both palladium and platinum.
Shares of SWC came down more than 30% from their mid-2014 highs as the price of palladium dropped, but global supply and demand factors could send the stock higher this year. Even if shares do not trend higher in the near term, they appear to have found support and are not likely to go much lower. This makes SWC the perfect candidate for a put selling strategy.
By selling a put option on this stock, we are agreeing to buy 100 shares per contract at the option’s strike price if shares are below that price when the option expires. For accepting this obligation, we are paid a premium, which lowers our cost basis. If shares are above the strike price at expiration, that premium is ours to keep free and clear.
With shares trading for $13.31 at the time of this writing, we can sell the SWC Feb 14 Puts for a limit price of $1.05 a share ($105 per contract).
If SWC does not move higher from here and closes below the $14 strike price at expiration on Feb. 20, we will be assigned shares at that price. Since we received $1.05 in option premium, our actual cost is $12.95 per share, a 3% discount to the current price.
We want to make sure we have enough money in our account to cover the potential purchase. This means setting aside $1,295 for every put contract we sell, plus the $105 we collected from selling the puts.
If we do get assigned, there is another income strategy that involves “renting” your shares to another investor. It’s just as easy as selling puts and could earn you thousands of dollars in monthly income on SWC and any other stocks in your portfolio. If you want more info on how you can use this strategy with the stocks you already own, check out this free report.
If SWC closes above $14 on expiration, we keep the premium for a gain of 8.1% in just one month. If we were able to make a similar trade every 30 days, we would generate a 99% annual rate of return. That’s a far cry from the returns most investors are seeing in precious metals.