South East Asia—the tree huggers' nightmare

by Christian DeHaemer

The first thing you notice when you get off the plane in Bombay is the air. It’s bad. It scorches your eyes and chokes up your lungs. The explanation is no further than the parking lot. Many millions of dirty little motorbikes scuttling around trailing long black clouds of exhaust.

There was a sign on the dashboard of the auto-rickshaw I took from the airport. It said, “This vehicle uses environmentally friendly unleaded gas.” This is India’s latest clean-air novelty. It makes you wonder if the catalytic converter could be far behind.

Tree huggers sound the alarm

Those who would save us from ourselves are sounding the alarm over a new environmental disaster. It goes by the name of the Asian Brown Cloud (ABC). It is a haze layer surrounding the whole northern Indian Ocean and much of South Asia, India, Pakistan, Southeast Asia, and China.

This haze shows up for four months a year and makes the cloud that overhangs Baltimore in August look like the sky in “Ferris Bueller’s Day Off.” Scientists first thought the ABC might be confined to major cities. As it turns out, it’s an enormous blanket covering the homes of 3 billion people, or about half the world’s population.

For the most part, I’m not one to give credence to the hyper-alarmist notions of environmentalists. Most of them simply want control over your personal property.

However, I was a boy in the 1970s and I distantly remember walking along the Hudson River near Albany, New York, and seeing the riverbanks lined with dead fish. Nobody swam in the Hudson. Things have changed. Anglers will tell you the mouth of the Hudson offers great sport fishing. A clean environment is an obvious choice for those that can afford it.

Asian Tiger growth factor

India is industrializing rapidly, and they don’t care too much about state-of-the-art, energy-efficient technology. Most of the new industries there are using old-fashioned, highly polluting engines and fuels. The types of factories that used to pollute the Patapsco River here in Baltimore are now spilling filth into the Ganges.

It is clear that India, China and the rest of the Asian tigers will need to enforce the use of catalytic converters.

When the catalytic converter was first made mandatory in the U.S. in 1977, there were 121 smog alert days in California—four months of acrid air. In 1997, there was only one such day… even though car use in California has doubled over that time. Sooner or later, this technology will come to South Asia.

I’m not telling you this to convince you to give money to Ducks Unlimited. No, I’m telling you this because the precious metals of the platinum group, including palladium and rhodium, have a unique combination of properties, making them the natural choice for catalytic converters.

A clean trend for the next decade

Unlike other precious metals such as gold and silver—which just sit there in the ground—there is an industrial use for palladium. And as you can see by the chart, it has been moving up after a long basing pattern. Rhodium has a higher beta and a long basing pattern as well. If you were more speculative, you’d invest in rhodium. As it is, both of these are buys.

An obvious way to play these metals would be to buy the largest producer of palladium in North America. That would be North American Palladium (PDL.TO).

As you can see by the chart, PDL has been in a basing pattern for over a year. This is due to the fact that income has held steady. However, if you look beneath the surface, you will realize that revenues have doubled.

In Q2, PLD realized net income of US$7,521,000 or US$0.15 per share (fully diluted) on revenues of US$41,745,000, compared to net income of US$7,707,000 or US$0.15 per share (fully diluted) on revenue from metal sales of US$21,178,000 for the corresponding period a year earlier. [All prices in Canadian dollars.]

PLD increased the production of palladium 207% year over year. Revenues jumped, cost per ounce of ore fell, but income remained the same due to a lower cost of palladium. Cash costs to produce palladium dropped to US$223 per ounce in the second quarter 2002 compared to US$274 per ounce in the second quarter 2001.

For the six months ended June 30, 2002, the company reported net income of US$13,767,000 or US$0.27 per share on revenue of US$86,322,000, compared to net income of US$8,990,000 or US$0.18 per share on revenues of US$41,381,000 for the six months ended June 30, 2001.

North American Palladium owns Canada’s only primary producer of platinum group metals and has one of the largest open pit palladium reserves in the world. The company has doubled revenue, increased output and reduced cost.

The auto industry in the United States, Japan and Europe continues to use palladium for controlling exhaust emissions. The natural trend worldwide has been to reduce air pollution. Any increase in the price of palladium will have a direct and leveraged effect on North American Palladium’s bottom line.

PDL has an estimated P/E of 14.2 for 2002 and earns 15 cents a share. Eighty-five percent of sales are from palladium. Annual production will increase to 250,000 ounces annually for the next 17 years (lifetime of mine).

This isn’t a short-term play. Don’t expect to take profits next week. But if you are looking for a safe, strategic long-term play on an obvious trend—this is your boy.

Buy PDL.TO. It is currently trading at US$8.20 Canadian.