Use Auto Stocks to Front-Run Palladium

by Daniel Putnam | May 10, 2013 9:45 am

Use Auto Stocks to Front-Run Palladium

Short-term traders are always looking for an edge when it comes to indicators, so they have to love the relationship between auto stocks and the ETFS Physical Palladium Shares (NYSE:PALL[1]). The Dow Jones U.S. Auto Manufacturers Index (DJUSAU) has consistently provided a reliable indication of palladium’s near-term direction.

And it’s providing one such signal right now.

Why Are Palladium and Auto Shares Related?

First, a quick review of why this relationship exists.

Palladium — along with platinum and rhodium — is used in catalytic converters, which reduce the toxic emissions produced by motor vehicles. More than half of the world’s palladium output is being used for this purpose, so the price of the metal is directly tied to the fortunes of the global auto industry. This relationship is being strengthened by the adoption of tougher emissions standards not just in the United States, but in emerging markets such as China — the primary source of incremental demand for autos.

Auto Stocks As an Indicator

The relationship between palladium and auto sales is reflected in the fact that the metal tends to trade in tandem with auto stocks over time. In the short-term, there can be divergences between the two. But in many instances, auto stocks have provided advance warning — in some cases, several weeks ahead — about the next move in the palladium ETF.

The most dramatic example occurred in 2011, when the DJUSAU began to fall in mid-May even as palladium continued to drift sideways. The two diverged for the next three months, and by August, the accelerated downturn in auto shares provided a preview of what was to come in palladium. The metal finally caught up to the autos in September of that year, falling off the table for a loss of 22.5% in the month.

Along the way, the DJUSAU provided signals of intermediate-term moves in palladium with lead times of anywhere from several weeks to several days, as indicated by the solid lines:

Pall11 Use Auto Stocks to Front Run Palladium[2]

In 2012, this relationship came into play again. Auto stocks outperformed PALL by a wide margin through the first three months of the year, setting up the mean reversion that occurred in April (the interval between the vertical lines in the chart below). However, this divergence also served as a signal that the days were numbered for the palladium rally. During May, the palladium ETF lost 10.5%.

Later in the year, auto stocks began to turn higher at the beginning of October, telegraphing a similar rally in palladium one month later.

Pall21 Use Auto Stocks to Front Run Palladium[3]

This year also has brought two early warnings from the auto sector. The first occurred in January, when autos peaked a month ahead of palladium, while the second occurred in late February, when the bottom in auto stocks preceded the bottom in PALL by a week. These two occasions are highlighted by the vertical arrows:

Pall3 Use Auto Stocks to Front Run Palladium[4]

That brings us to the present. The Dow Jones U.S. Auto Manufacturers Index has tacked on nearly 15% since April 6, whereas palladium has declined a little over 5% in that time. If the pattern of the past two years holds true, palladium is due to play catch-up from here.

Watching relationships such as these is no guarantee, and success in this type of trade is obviously a matter of timing. Still, monitoring the relative performance of autos and palladiums might be the ticket to a few extra percentage points of return in your trading account.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. PALL: http://studio-5.financialcontent.com/investplace/quote?Symbol=PALL
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/05/Pall11.jpg
  3. [Image]: http://investorplace.com/wp-content/uploads/2013/05/Pall21.jpg
  4. [Image]: http://investorplace.com/wp-content/uploads/2013/05/Pall3.jpg

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