(Kitco News) - A renewed focus on reportedly declining Russian stockpiles sent palladium prices sharply higher so far this month, with the metal hitting an 11-week peak on Wednesday.

The market has also drawn support from demand factors, such as improved prospects for auto sales and the start of buying ahead of the Chinese New Year next month, traders and analysts said.

The most-active Nymex March palladium contract has been as high as $689.90 an ounce, its most muscular level since Sept. 21. At Wednesday’s peak, it had gained $77.30 since the November close.

“This is predicated on tightness out of Russia,” said Jim Steel, precious-metals analyst with HSBC.

Early this month, Norilsk Nickel’s marketing director, Anton Berlin, said that his company believes Russian stocks are “almost depleted.” He cited news reports earlier in the year quoting a government source as saying Russian exports would fall to 150,000 ounces annually for 2012 and 2013. Norilsk Nickel expects palladium to be in a deficit next year, Berlin said, speaking at a conference sponsored by ETF Securities.

The Russian government does not release data on the amount of palladium in state stockpiles. If it is near depletion, this would reduce the amount of palladium available to the market each year.

“There is growing evidence that Russian supplies are dwindling and we’re going to see some supply tightness in the market,” said Bill O’Neill, one of the principals with LOGIC Advisors. “Russia, of course, has been the No. 1 seller or provider of palladium, so it’s very, very crucial…Russian supplies are really the key to the rally.”

Last month, Johnson Matthey released a report saying the palladium market would be in a surplus of 725,000 ounces in 2011. The balance included estimated sales of 750,000 ounces from Russian state stocks, meaning the market would be nearly balanced without those supplies.

O’Neill also cited improved auto sales in the U.S. as one of the influences behind the recent uptick in palladium. The main industrial use for palladium is auto catalytic converters. The seasonally adjusted annual rate of sales in November was 13.6 million units, up from 12.28 million in November 2010, according to Autodata.

“We’re probably going to see palladium demand this year about 6% to 7% higher than it was in 2009, when all is said and done,” O’Neill said. “The demand side is quite good.”

Further, analysts with Barclays Capital say there are signs of strength in Chinese auto sales. The country has become the world’s largest auto market.

Steel also cited ideas in the marketplace that there is a continuing shift in which auto makers are trying to use more palladium in catalysts, whenever possible, rather than more-expensive platinum.

Meanwhile, buying interest for palladium appears to be picking up out of the Far East ahead of Chinese New Year celebrations next month, said Afshin Nabavi, head of trading at MKS Finance. This is a period that typically leads to improved Chinese demand for gold. But with gold prices at historically high levels, some buyers may view palladium as a substitute, he said. China is the world’s largest market for both palladium and platinum jewelry.

Another trader reported that there is conjecture that fund-related buying is starting to pick up, including exchange-traded funds.

“When it got down around the $600 level, it was a good play for investors again,” he said. “A lot of funds are getting back into it again.”

Otherwise, a couple of major banks reported that there have been outflows from exchange-traded products so far this month, leading one to suggest that much of the buying in the current rally may have been in the form of short covering.

Barclays, in a daily commodity research report, said palladium exchange-traded product outflows have hit some 21,000 ounces so far in December following outflows of 84,800 ounces in November. Total holdings are at their lowest since March of last year, Barclays said.

“It is…interesting that the latest price rise was not accompanied by corresponding inflows into the ETFs,” said Commerzbank, adding that “holdings of palladium ETFs have continued to fall, which would indicate that short coverings are the main driver of the climbing prices.”

Short covering is a form of buying in which traders are offsetting, or exiting, positions in which they previously sold.

Nabavi pointed out that palladium’s rise has come during a period of declining liquidity ahead of year-end. By somewhere around Dec. 16 to 21, much of the activity likely will be book-squaring rather than fresh positioning ahead of year-end, he said.

“It is a very thin market, so if there is a supply disruption, it doesn’t take a lot to get the market moving,” O’Neill said.

Palladium may have further room to the upside, some analysts said.

“I’m pretty bullish on palladium medium to longer term,” Steel said. “It has withstood a lot of selling.”

O’Neill also anticipates more strength, particularly if the global economy expands.

“Right now, we’re dealing with relatively tame global economic growth,” he said. “But one of the bright sides has been auto sales. If we start to see significant improvement in the global economic scenario, certainly that will add to the bullishness of palladium. I don’t see that happening in a big way near term, but long term, palladium sets up as a very bullish metal because of the fact it does appear that Russian supplies are considerably down from where they were years ago.”

By Allen Sykora of Kitco News; asykora@kitco.com

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