The Palladium ETF Is The Ultimate Volkswagen Victor

The American depositary receipts (ADRs) of German automotive giant Volkswagen AG VLKAY are down more than three percent at this writing Friday and have touched a new 52-week low.

Volkswagen ADRs have plunged 36.5 percent over the past month following an emissions scandal and reports of fraudulent software in a sizable percentage of Volkswagen models on the road in the U.S.

As Benzinga reported earlier this week, Bank of America Merrill Lynch analyst “Teo Lasarte sees four potential risks to the company as the Volkswagen emissions scandal continues to play out. Risks include regulatory fines, lawsuits, recall costs and a potential capital increase to the company’s financial segment. At this time, developments are too early-stage for Bank of America to attempt to quantify these risks accurately, but Lasarte estimated that the company could face €26.5 billion in liabilities.”

Lasarte is just one analyst. Others have heaped bearish calls on Volkswagen as well and with the risks outlined by Lasarte nowhere close to being resolved, it is reasonable to expect the sell side will not be warming to Volkswagen anytime soon.

Volkswagen's negative impact on exchange traded funds has not been too dramatic, but there has been fallout. For example, the iShares MSCI Germany ETiF EWG is off more than five percent over the past month as its weight to Volkswagen has dwindled to just 1.7 percent. The First Trust NASDAQ Global Auto Index Fund CARZ, the only dedicated automotive ETF, is lower by 2.2 percent over the past month. CARZ has a Volkswagen weight of less than 2.4 percent, according to First Trust data. 

Just as EWG, CARZ and other ETFs have struggled in the wake of the Volkswagen scandal, the ETFS Physical Palladium Shares PALL has flourished. Perhaps you're hearing that precious metals are trading higher Friday because of the slack September jobs report. Well, PALL is up 3.4 percent at this writing on volume that has already eclipsed the daily average because Volkswagen ADRs are lower. Today's jump brings PALL's one-month gain to 21.6 percent.

Over the same period, the SPDR Gold Shares GLD, the largest commodities ETF, is up just 0.8 percent. PALL is the palladium equivalent of GLD as the former holds physical palladium.

Volkswagen's woes have been a boon for PALL for a simple reason: Diesel automobiles require platinum for the production of catalytic converters and it is diesel that has gotten Volkswagen in trouble. Volkswagen explains why PALL's platinum-based cousin, the ETFS Physical Platinum Shares PPLT, is off nearly 10 percent over the past month.

Platinum now resides at its lowest levels in 13 years against palladium, according to Platts. For its part, palladium is the key ingredient in the production of catalytic converters for gasoline-based automobiles. 

Forgive me for adding a personal anecdote, but perhaps it will prove instructive regarding PALL's recent strength. PALL came to market in January 2010 and I've covered the ETF for various reasons over that time.

Experience has taught me there are two fundamental catalysts that have the power to move PALL. Supply concerns, either by way of traders fretting about dwindling supply in Russia or labor strikes in South Africa. Russia and South Africa are the two largest palladium-producing nations. Or automotive demand.

Most of the automobiles produced in the U.S. and China, the world's largest automotive markets, are gas-powered, meaning manufacturers require palladium, not platinum, for the production of catalytic converters. Put simply, the longer Volkswagen's problems persist, the more upside PALL might have.