In early 2008, when South Africa's electricity crisis first came to a head and emigration applications soared, the platinum price ratcheted up, too.
In early 2008, when South Africa’s electricity crisis first came to a head and emigration applications soared, the platinum price ratcheted up, too. Though a seemingly perverse reaction to adversity in the energy-reliant sector, the price response was shrewdly rational. Because South Africa accounts for just less than 80% of the globe’s platinum extraction, any restriction on its ability to bring the white metal to the surface—including the absence of a reliable and adequate power source—implies serious supply constraints for the world market.
With the prospect of a supply shortage, the price spiked. Although a sentiment-driven rand drop added to the general distress at the time, it brightened platinum miners’ prospects further because it opened up the gap between dollar-denominated sales and rand-based costs. Seeing the opportunity, investors piled into South African platinum stocks and the local index lifted handsomely.
Since those heady days, though, there has been little to like about the sector. “The platinum sector has been one of the worst performers in our market since its 2008 peak,” said Investec Asset Management portfolio manager Rhynhardt Roodt.
“The sector has been dogged by rampant wage inflation, well in excess of general inflation. Increasingly stringent safety standards and the gradual shift towards having to extract ore from the deeper UG2 (upper group 2) Reef, whose grades are poorer than the shallower and richer Merensky reef, have added to the rapid rise in costs.
“On the revenue side, the platinum price has pulled back from its highs. Not surprisingly, some of the mines at the higher end of the cost curve have not made much money in recent years.”
Putting numbers to these developments, Roodt illustrates just how harsh conditions have been for the miners. In rand terms, the platinum price has dropped 27% from its 2008 peak; taking the average price near its top, the decline has been about 20%. As a group, platinum stocks listed on the JSE are down more than 55% since their highs at the end of the first quarter of 2008.
Within the mix, the large-capitalisation platinum miners—Anglo Platinum and Impala Platinum—outperformed the mid-tier players—Aquarius Platinum and Northam (Royal Bafokeng listed late last year)—and the junior miners—Anooraq, Eastern Platinum and Wesizwe (Eland Platinum has been bought out)—over this period. Lonmin was the exception, faring more poorly than its peer group of big players.
“Generally speaking, the past few years have not been good for smaller cap stocks, because investors have preferred the safety of bigger companies,” Roodt said. “Additionally, most of the junior miners carry so-called project risk in that they have only one big project, or possibly a second, unlike their large counterparts whose assets are diversified.
“What’s more, most of them are not yet in production. Many of the smaller platinum mines listed during the 2006-2008 period when markets were booming and funding was readily available. When times got tougher, investors became more demanding, having felt, in some cases, that the initial promises made had not been met.”
Given the recent track record of the sector and mixed signals about the likelihood of any improvement in the fundamentals for platinum and the cost of its extraction, fund managers are wary about building too big an exposure to the metal.
Reading the evidence, Francois du Plessis from private-client fund manager Vega Capital believes it best to avoid platinum stocks in favour of diversified commodity players such as BHP Billiton. “Diversification across a number of resources is a comforting risk remedy in these times.
“Undoubtedly, there are some positives in the outlook for the platinum price, including the prospect of rising jewellery demand in China and the expectation of a near-doubling of the number of cars on the planet by 2030, with both demand sources already a significant proportion of total demand for the metal.”
Du Plessis’s concerns outweigh these pluses, though. They include the potential for a mild recession in Europe that will inhibit the shorter-term demand for auto catalysts and the recent forecast by chemicals firm Johnson Matthey’s research arm, which indicated that the platinum market would swing into surplus this year from a modest deficit in 2010.
“Equally worrying is the fact that the price-earnings multiples of local platinum shares, using analysts’ one-year earnings forecasts, are at a premium to that for the JSE all share index. The metrics suggest the stocks are vulnerable to possible downgrades in earnings,” Du Plessis said.
Lentus Asset Management’s Nic Norman-Smith, a value investor who often sees a buying opportunity where others see problems, has a different perspective.
“Platinum is 30 times rarer than gold, with many more industrial uses. Yet the gold price is trading at a premium to the platinum price, which fundamentally doesn’t make sense. This is a high-level indicator that this price relationship is not sustainable.”
Turning to the expected performance of platinum relative to industrial metals, Norman-Smith expects a greater likelihood of what he describes as rational behaviour in platinum. “Because supply is very concentrated in the hands of a few producers in South Africa and Zimbabwe, we are unlikely to see massive volumes coming on-stream. The likes of Anglo Platinum and Impala Platinum are in it to stay in business,” he said.
“By contrast, as the price of iron ore and copper shot through the roof because of rising Chinese industrial demand, we’ve seen the opening up of scores of new iron ore and copper mines. At some point oversupply will become a factor in the markets for these metals, whose prices now trade well above the marginal cost of extraction. For platinum, whose price is trading at close to the marginal cost of extraction, there is much less downside risk.”
Ongoing fears about cost pressures in South African mining, which continue to plague the ratings of local platinum stocks, is another reason for Norman-Smith’s willingness to take a bet on platinum. “From a behavioural finance point of view, we would rather be in a place that everyone hates.”
Norman-Smith prefers the relative safety of the larger players, and Anglo Platinum in particular, because of the fact that they are least favoured by the market.
Sanlam Private Investments’ chief investment officer, Alwyn van der Merwe, is another investor looking beyond the funk hanging over the platinum sector. He believes those with a long-term perspective can start buying the larger stocks. “The recent disappointing quarterly production report from Impala Platinum emphasised just how big a battle it is to get platinum out of the ground in South Africa, which is good for the metal price. Sure, there are cost issues in the sector and demand is always going to be cyclical, but the big miners have good assets.”
Van der Merwe says one’s stock pick in the sector depends on one’s view on the metal price. “Anglo Platinum is more geared for a higher price and will therefore outperform if there is a notable platinum price movement. Impala Platinum, with its lower cost base, will have a better showing if price gains are more moderate.”