Of all the precious metals of interest to investors, palladium may be the one to watch going into the second half of 2012.

Palladium’s supply and demand fundamentals are bullish for the metal’s price, with a widely predicted supply deficit starting this year and deepening by next. Meanwhile, demand is rising.

Still, you would never have guessed that based on its recent performance. Currently, the price isn’t far off its lows. The problem to date is that in a “risk on” environment, palladium, which is used largely in automobile catalytic converters, has been getting shorted aggressively, especially by the hedge funds, says Wiktor Bielski, the London-based global head of commodities research at VTB Capital, the Russian investment bank. To understand why palladium has traded down despite the strength in the auto market, you have to keep an eye on the long versus short statistics released every Friday by the U.S. Commodity Futures Trading Commission, Bielski says, noting that all of the industrial metals are trading like risk assets right now. With palladium, “I have to say that anybody playing the short side has done very well,” he says. But, Bielski insists, “you can’t fight the fundamentals forever.”

After hitting a year-to-date high of 71.51 on February 22, ETFS Physical Palladium Shares (PALL), the only U.S.-listed ETF backed by physical palladium, closed on July 9 at 57.48, a decline of 19.6 percent. At this level, PALL isn’t far from its 52-week low of 52.90, and it’s well off its 52-week high of 83.90.

Is there a lot of mileage left in shorting palladium? “Probably not,” says Bielski. “The risk/reward is clearly skewed more to the upside.” He predicts that as a result of the way palladium has been beaten down by the shorts, “the stronger and more sustained the rally will be when it comes.” Just when that will occur, he says, “is just impossible to predict at this point, unless you have a line into Ms. Merkel and the euro zone leaders.”

One of the leading reasons why a number of fundamental commodity analysts like Bielski are strongly positive on palladium is that Russia has announced that 2012 will be the last year for sales from its Cold War–era stockpiles. Back then, Russia was mining nickel aggressively to build military equipment, and it ended up with lots of palladium as a by-product. Up until now, Russia has been the second-largest producer of palladium (behind South Africa), with over 46 percent of global annual production, according to research from ETF Securities of London, PALL’s sponsor.