By Peter Hobson
LONDON (Reuters) - Palladium <XPD=> is outgunning other precious metals, with a surge to record highs putting it within a whisker of parity with gold <XAU=> for the first time in 16 years.
Tight supplies, large deficits and resurgent interest from speculative investors have sent palladium prices rocketing 40 percent from a low in August.
The metal, used chiefly in emissions-reducing autocatalysts for vehicles, reached an all-time high of $1,185.40 an ounce on Friday - a mere $35 short of gold at around $1,220.
(Graphics of 'Palladium prices relative to gold and platinum' - https://tmsnrt.rs/2PugPWq)
"What we are seeing is the culmination of several years of sustained market deficits," said Mitsubishi analyst Jonathan Butler.
"Clearly it (the rally) has still got some legs. $1,200 is an immediate psychological level. I could see us going towards $1,300."
The physical palladium market is the tightest in nearly two decades, analysts at Citibank said.
Autocatalyst maker Johnson Matthey expects a deficit of 239,000 ounces this year, while researchers GFMS - who predict lower supply and higher investment - see a shortfall of more than 1 million ounces in each of the three years to 2020 in the roughly 10 million ounce a year palladium market.
That gap is hard to fill with new production because palladium is mainly a byproduct of other metals such as platinum and nickel, and South Africa, a top producer, is shuttering unprofitable platinum mines.
(Graphics of 'Palladium supply and demand' - https://tmsnrt.rs/2PjXa7u)
Prices have spiked despite weaker car sales in recent months in China, the world's biggest market, and flat sales in the United States, which have led some analysts to sound a note of caution. The auto industry accounts for 80 percent of palladium demand.
"The cyclical backdrop in China remains very weak," said Julius Baer analyst Carsten Menke.
"Car sales continued to fall in early November ... Amid all the talk about another round of tax cuts, similar to those introduced in late 2015, it looks like more and more consumers are staying out of the showrooms."
(Graphics of 'U.S. and Chinese car sales' - https://tmsnrt.rs/2PufzCN)
Another fear is that a U.S.-China trade war will puncture global economic growth and curtail car sales.
But the risk that auto makers will substitute palladium for its cheaper sister metal platinum has not yet materialised, according to Citibank.
"Auto makers need a wider price differential, or more certainty that global growth will remain solid and prices will remain high, before switching occurs," they said, predicting prices at $1,200 in the second quarter of 2019.
Bolstering a bullish case for palladium is a shift by European car makers towards palladium-heavy gasoline-powered cars after a diesel emissions scandal, and emissions regulation that will likely require larger loadings of precious metals in autocatalysts.
Added to that are falling palladium stockpiles.
Inventories in warehouses monitored by the Nymex exchange, at 46,965 ounces, are near their lowest since 2003. <PA-STX-COMEX>
Holdings of palladium-backed exchange traded funds (ETFs), which have helped to plug gaps in the market in recent years, have fallen below 800,000 ounces from 2.6 million ounces in 2015. <HLDTOTALL=XPD>
(Graphics of 'Palladium stockpiles' - https://tmsnrt.rs/2PvLD9b)
The market remains in backwardation - meaning that nearby metal costs more than metal with later delivery dates - suggesting that supply is short.
Demand from industrial users remains strong, said Mitsubishi's Butler.
Speculative investors, meanwhile, have remained reluctant to ramp up bets on higher prices.
Their net long in Nymex palladium collapsed from more than 27,000 contracts, equivalent to over 2.7 million ounces, in January to 110,400 ounces in August. They have since made only a partial recovery to just under 1.4 million ounces. <3075651NNET>
(Graphics of 'Palladium positioning' - https://tmsnrt.rs/2PxeCtv)
That financial selling, rather than a lack of industrial demand, explained the fall in palladium prices over the January to August period, said ICBC Standard's Garvey.
Revived buying by speculators could help palladium to overcome technical resistance at its long-term uptrend line from 2011.
A return to the average long position on Nymex over the last 10 years would drive prices up by a further 20-40 percent, Citibank said.
(Graphics of 'Palladium technicals chart' - https://tmsnrt.rs/2PyzbFC)
(Reporting by Peter Hobson; Editing by Veronica Brown and Louise Heavens)