The smaller the amount of material of any kind that there is to buy and sell, the more likely it is for that material to be priced at the margin, i.e., for its price to be simply that of its last trade without regard to that part of the seller's margins determined by its actual average supply and demand. What surprises me is what amounts of material and money are considered today to be small.

A perfect example of this phenomenon is the run up in the last year – at least until last month, July 2007 – of the price of the platinum group metal, ruthenium.

Since retiring as the CEO of a small OEM automotive supplier a few years ago, I have become a writer of and a consultant to financial institutions on the issues of sourcing strategic and critical-use metals and minerals. This is increasingly viewed today as a necessary part of the due diligence for investments in industrial manufacturing companies, particularly those in the OEM automotive sector.

I am usually – lately, rather frequently – called upon to discuss "demand drivers" for specific metals and to correlate demand with long term supply availability and the opportunities and procedures for the management of the risks both of a shortage of the metals and/or extreme swings in their prices. I try very hard to keep abreast of all of the news about strategic metals, but nonetheless I admit that I was surprised last week to be asked to discuss the "market for ruthenium" by a representative of a very large and prominent investment bank.

Ruthenium is slightly more plentiful, supply-wise, than rhodium, but ruthenium is not as critical a material in our daily lives as rhodium. This is because the American OEM automotive industry cannot build or sell a vehicle legally which is not equipped with an exhaust emissions control device that will ensure that nitrogen oxides formed during internal combustion engine operation are reduced back to elemental nitrogen before they exit the vehicle's exhaust system into the air. The only way known today to do this economically in a device which uses the catalytic properties of platinum and palladium to ensure the complete combustion of carbon based materials, such as carbon monoxide and unburned gasoline, to carbon dioxide and water, is to pass the gases over an activated rhodium metal catalyst. No economical substitute for rhodium has so far been developed for this critical, no-build-without-it application.

Ruthenium has been used up until recently only as a specialized catalyst for organic chemical reactions, a minor alloying element (for hardening usually), and in electronics for its optical and magnetic properties, albeit in ways that use miniscule amounts of the physical metal.

Small investors must be very careful not to be influenced by a price volatility pattern that is common with commodities for which little or no information on supply and demand is openly available. The market for metals with tiny global production is opaque, the opposite of transparent. The only light of information that comes through to the investor in those markets has been carefully filtered by parties all of whom have a strong interest in selling the material at the highest possible price. A trade that occurred around Christmas in 2005 in the rhodium market is illustrative of the typical trading pattern for end-user inventoried niche metals with industrial uses, which occurred again in the ruthenium market within the last year.

Both metals rhodium and ruthenium come from the same geological source, they are both by-products of the mining of platinum and both are mostly produced in South Africa.

It seems to be the belief and, worse, the operating agenda of many people narrowly, lightly or not at all educated in the sciences – who are also members of the finance staffs of American heavy manufacturing companies – that if you are willing to pay any price you can always obtain any natural resource without any time delay from the free market.

This erroneous assumption, which can be so easily refuted by simply speaking to a mining geologist, has raised costs in American heavy industry, just in the last decade, to the point where many now believe that natural resource prices are the primary driver for specific sector bankruptcies, even though the risk of price volatility could have been managed by the application of a holistic overview before it got out of control..

In late December 2005, as an illustration of the above statement, the financial manager in charge of nonferrous metal commodity management in the purchasing department of a great American OEM automotive corporation was asked by his equally obtuse superiors to find some cost savings or revenue under his control to make the corporation's end of the year numbers look better. He decided that much of the corporation's physical possession of a substantial store of rhodium, a no-build without metal, could be sold off at a much higher price than that at which it had been purchased and that it would be easily replaceable in the "free market" at a similar price if it were rapidly bought back after the accounting period ended. This had apparently had been done before.
Of course this man sold into a bull market for rhodium, and he got a price higher than the average of his inventory basis. So, like any finance staff member with no knowledge of niche metal markets or their timing, he was happy. But he was not to live happily ever after. His company needed rhodium on a daily basis, and he had sold too much in the classic "a little is good, a lot is much better" thinking of finance staff members.

By the time he went into the market to replenish his stock of rhodium, the price of rhodium was surging. The problem for the great corporation was that the price of the catalytic converters was determined by a program into which you entered the prices of the components daily. As soon as this man made a buy of rhodium at the new price the financial planners saw a red flag. Why, they asked, had this happened? Why was a component with a stable price suddenly becoming linked to a surging market? The answer was: "You told me to do it." This is a bad answer in a pyramidally organised corporation if you want to ascend the pyramid. I don't know what happened when he told them that the converters would go up in cost each day as the rhodium price continued escalating.

The man in the story above was eventually moved laterally in the great corporation. It solved the problem he was blamed for in general by eliminating the position of commodity specialist for niche metals, a man who had previously reported to the now laterally transferred individual. The great corporation today has no one in its purchasing or finance group who knows anything about rhodium besides what they read in the American Metal Market or in the Johnson-Matthey annual survey of the platinum group metals. All is now well and quiet, and it is the market and not our interaction with it that is to blame for any rhodium problem. Right?

The same type of thing described above happened in the ruthenium market during the last year, but the outcome was better for Brush Wellman, which also sold its reserve stocks of ruthenium into a bull market. In that case Brush, the world's leading producer of beryllium metal products, was holding a relatively large amount of ruthenium, which it uses to make exceptionally strong beryllium copper alloys for rough service electrical contact applications.

Brush had been stockpiling ruthenium historically because it was cheap and sometimes its few producers were holding it hoping that the price would go up, so you always needed a safety margin of inventory overhang. Two years ago, in 2005, ruthenium was $100.00 an ounce. It was a low demand item, but since it, like rhodium, is produced primarily as a by-product of platinum production, its supply was continuing to grow because of the increases in the demand for platinum production for environmental management.

Finally, the world's largest producer (and usually stockpiler) of ruthenium, Anglo Platinum, caught a break that also helped Brush Wellman. It was discovered in the last few years by the computer components industry that an increase in the physical amount of ruthenium already being used to coat the basic magnetic film on a hard drive disk caused a dramatic increase in the storage capability of the drive by allowing magnetic "bits" of information to be stored closer together than ever before possible. The computer component manufacturing industry began to change over to the new technology in earnest in mid-2005. Although the actual amount of ruthenium used per hard drive is tiny, the amounts needed were clearly growing.

Because it was relatively cheap and because, due to increasing prices, the inventory was being released, companies like Intel, IBM, Seagate, Samsung, Toshiba, and Phillips, among others began, in late 2006, to buy for their inventory as well as their immediate needs. As soon as the South African producers saw this demand spike, they began pricing ruthenium at the margin. Impala Platinum (Implats), for example, noted that its (by my calculation) 300,000 ounces of ruthenium sold in the last six months of 2006 for $30 million would, if early February 2007 prices prevailed, fetch $250 million in the same time in 2007. This is not simple supply and demand, nor speculative – it is panic buying.

No small investor or buyer without a critical no-build need for ruthenium should go anywhere near such an opaque volatile market without heavy duty asbestos covers on sensitive parts of the body and wallet.

Brush Wellman's customers buy exotic metal alloys from Brush – for most of which it is the sole supplier. If ruthenium is needed for their alloy, they will either supply it to Brush or pay its market price. I have no doubt that such customers have been in the market during the panic buying spree.

One ruthenium trader -yes, there is such a specialty – at a major European precious metals dealer told me that the annual global production of ruthenium is about 800,000 troy ounces, about the same as rhodium. In 2006-2007, the annualized demand, which was met, was 1,200,000 troy ounces. The surplus came from some of longstanding inventories, which may not yet be exhausted.

I predict that ruthenium demand will drop substantially in the next year due to bulging inventories at critical end users. The opacity of the ruthenium market does not give us any indication of producer inventories.

If the demand from producers is less than 800,000 troy ounces in the next year, then producer inventories will increase or build again because those companies must continue to produce platinum. In that case the price of ruthenium will drop. The important thing for end user buyers to watch is for another end user to sell off inventory. This will not necessarily be public knowledge but it may be "outed" by aggressive inquiry into quarterly and annual reports. Should such a sale occur, it will mean either that the seller wants to cut his inventory cash outlay or that the seller sees an oversaturated demand, which, when generally known, will drive the price of his ruthenium inventory down. In the event that a better or cheaper coating than ruthenium should be discovered or announced, the ruthenium price will crash because of its limited uses otherwise.

I doubt very much whether the producer seller of excess ruthenium inventory will ever want it back other than perhaps to shore up prices for a short term play. This is something to look for also, although it is extremely difficult to know when a producer is buying a non-exchange traded metal.

I think that the current, perhaps already over and certainly overheated ruthenium bull market is just that: bull.

Some agree with me:

In 2006, Anglo Platinum's production of ruthenium was greater than its rhodium. The short-term price outlook for ruthenium was strengthened by the fact that hard disk manufacturers had to build up stocks for this new application, but, like Implats, Anglo Platinum did not believe that the current high price could be sustained.

Others disagree:

JP Morgan reckons this former nuisance metal could become a handy "profit kicker" for South African platinum miners. "We believe there's a good chance that this forgotten metal will move into four digits soon," said JP Morgan's Johannesburg-based precious metals analyst Steve Shepherd. – Resource Investor