* Boost from S.Africa unrest unwinding
* Underlying demand picture from carmakers still soft
* Physical palladium funds well down from Feb 2011 peak
LONDON, Oct 29 (Reuters) - Palladium is heading for its biggest one-month drop since May in October as a weak demand picture for the autocatalyst metal reins in gains made on the back of U.S. monetary stimulus and a sharply higher platinum price.
Prices swung to their lowest since mid-August last week from the six-month high above $700 an ounce they hit in September, helped by euphoria linked to the Federal Reserve's $40-million-a-month liquidity boost for the U.S. economy.
As that dissipated, investors were faced with a glum underlying picture for the metal which, despite the promise of longer term support, could lead prices lower still.
``Palladium, even more than platinum, is dependent on what's happening in the auto industry,'' Bank of America-Merrill Lynch analyst Michael Widmer said. ``And you have to say, Europe is not looking good, China car sales and production have for a good part of the year been relatively soft.''
``The market is overall still tight, but that doesn't really matter if you have a lack of demand,'' he added.
A spate of carmakers in Europe, including Ford, Volvo, Daimler and Renault have released downbeat statements on production this month.
Even China, long seen as a rare bright spot for the motor industry, has shown signs of slowing. Chinese vehicle sales fell for the first time since January in September, and grew just 3.4 percent in the first nine months of the year.
``A lot of the excitement about palladium in 2010 was based on growth in car sales in China and other fast-growing markets,'' Mitsubishi analyst Matthew Turner said. Palladium outperformed gold and platinum that year to more than double in price.
``These forecasts were assuming 10 percent growth every year for decades, and at the moment there's some scepticism about that. That has hurt the very bullish outlook.''
That has led some investors to pull out of palladium investments like exchange-traded funds. Since the end of February last year, palladium ETFs have seen outflows of more than half a million ounces, while platinum ETFs have recorded inflows of nearly 210,000 ounces.
Palladium's more pronounced exposure to the industrial cycle - it also lacks platinum's strong jewellery demand base - helped push its ratio to its sister metal to its highest in nearly a year last week.
Palladium's September gains were also driven by a surge in platinum prices after labour unrest in the South African mining sector led to dozens of deaths and cut output at miners like Anglo Platinum, Lonmin and Royal Bafokeng.
Basing palladium investment on a rising platinum price under those circumstances was not necessarily a good bet.
While platinum supply is disproportionately reliant on South Africa, which accounts for around three-quarters of global output of the metal, palladium is not. South Africa makes up just a third of its supply base, with Russia the major supplier.
``If platinum rallies for fundamental reasons specific to platinum, palladium shouldn't follow,'' one platinum group metals trader said.
``If you have a broad commodities rally and a lot of the investment baskets buy platinum, they will probably have to buy palladium as well, so there is a reason for them to buy in tandem. They don't differentiate in that sense. But palladium shouldn't have rallied with platinum (in this situation).''
Longer term, the outlook for palladium will depend heavily on the health of the global economy. Once that starts to pick up, the advantages palladium has over platinum make it well positioned to move higher.
``It has become the metal of choice in cars - most cars are gasoline, and palladium has taken market share in diesel, because it does more or less the same thing, and it's cheaper,'' Mitsubishi's Turner said.
``The fact that it doesn't have a South African story means that, though it hasn't gained as much as platinum, in the long term it probably makes it more appealing to end users,'' he said. ``The supply sources are more varied and less dependent on one country.''
(Reporting by Jan Harvey, editing by Wiilliam Hardy)