Washington (Platts)--14Jun2011/617 am EDT/1017 GMT

The likelihood of a continued recovery in the Japanese auto market and insufficient Russian stockpile sales make palladium fundamentals appealing, analysts with Australia-based Macquarie Bank said in a report Monday.

Macquarie analysts agreed with those who believe the Japanese disasters of March 11 triggered a substantial selloff by investors, with physical holdings by exchange-traded funds falling a sizeable 164,000 oz in March alone.

"The degree of selling of ETF holdings (3.3% of annual demand), however, seems to be much larger than the actual losses to auto maker demand, especially in light of the recovery in the auto supply chain," Macquarie analysts said.

As and example, Macquarie analysts cited reports indicating that Japanese auto company Toyota expects to return to 90% of pre-quake production levels this month. "This is not just important for Japanese auto production, which collapsed 60% year over year in April, but also for production by Japanese brands offshore, which reached [about] 13 million in 2010," Macquarie analysts said.

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Of greater long-term importance to palladium is auto production trends in China, analysts said. Production has been weak since the start of 2011, rising 4.8% year to date, compared with the 32.5% gain in 2010.

Auto parts supply from Japan following the March earthquake and tsunami has been an issue, but Chinese demand has also been weak, analysts said. The weaker demand was due in part to policies aimed at auto ownership, including limits on new license plates in Beijing, which caused a 62% year-over-year decline in sales, according to Macquarie.

A consumer confidence survey undertaken by Macquarie economists also suggests Chinese buyers currently are not in the mood to purchase a new car, analysts said. As a result, net Chinese consumption of palladium is expected to grow by 60,000 oz in 2011.

"What seems more important to the market balance in the immediate term are the 'known unknowns' of ETF demand and Russian stockpile sales."

Macquarie analysts pointed to signs suggesting Russian state stockpile sales of palladium will not be zero this year, and that additional sales would be made next year.

"The magnitude of these sales is not clear, but it is notable that while there is likely to have been some stockpile sales this year already, they have not been particularly disruptive," Macquarie analysts said.

For example, few significant palladium shipments have been made from Russia to Switzerland over the past few months, analysts said. In addition, few large shipments of Russian material stored in Switzerland long ago appear to have been made.

"We are assuming 300,000 oz of stockpile sales for this year and no flows into ETFs for the year as a whole (from the current position of -75,000 oz) and the market still appears to be in deficit, albeit smaller than last year," the analysts said.

"That said, if investor interest return to even a third of the [nearly] 1 million oz of ETF inflows seen last year, then that deficit is likely to be much larger and price appreciation rapid."

--Nick Jonson, nick_jonson@platts.com