Pent-up palladium stockpile likely to clip stellar 2013

* Palladium market to be in deficit for 2nd year in 2013

* Higher prices could trigger sales from large stocks

* Speculators remain bullish but upside capped

LONDON/SINGAPORE, Jan 14 (Reuters) - A recent rally in palladium is likely to run into headwinds in coming months as its higher prices attract a load of stockpiled and recycled metal onto the market.

The metal, used mainly in catalytic converters for gasoline-powered vehicles, rose nearly 11 percent in the last quarter to over $700 per ounce, while prices of the other precious metals fell.

Analysts say an improving outlook for the global economy, especially for the United States and China - the world's top car markets - plus a drop in supply from both Russia and South Africa is likely to tighten the palladium market in 2013.

But the road to higher prices will be far from smooth as the market encounters pockets of selling waiting along the way.

"A deficit is a positive indicator for prices, but a deficit of itself clearly isn't enough to mean that prices rise strongly," Mitsui Precious Metals analyst David Jollie said.

For the full year 2012, even while the market was on track to record its biggest deficit in 12 years, the average palladium price (based on daily market closes) fell more than 10 percent from the average in 2011.

"There's no doubt that as we see prices above $700, given the price weakness that we had last year, a variety of people holding above-ground stocks will see that as an opportunity to take profits," Jollie said.

"That doesn't mean that prices won't rise; but it does mean that as they rise, you will see selling pressure develop."

Some palladium stocks are held in Swiss warehouses, others by industrial users such as carmakers and some by traders.

DEFICIT

Leading banks forecast a deficit of 340,000 to 740,000 ounces this year after refiner Johnson Matthey said in November that the market, already registering a shortfall last year, would stay tight in 2013.

Demand from carmakers is expected to improve.

U.S. car sales are expected to rise to over 15 million units this year after hitting a five-year high in 2012.

China, the world's top car market, is likely to see single-digit growth in 2013 in car sales, after the first 11 months of 2012 recorded a 4 percent rise from a year earlier.

The U.S. market is particularly exciting to palladium bulls due to the higher average loading, or ratio to platinum used, in its vehicles as well as to the prospect of a wave of buying not that the fleet has become the oldest in history.

"U.S. household balance sheets have improved significantly and are currently at the healthiest level in a decade," Carlos Gomes, a senior economist at Scotiabank, said in a research note.

"Households have deleveraged by a trillion dollars over the past four years, leaving them in good shape to replace many of the clunkers still on the road."

Concerns about supply also lurk. Sales from the Russian state stockpile, which kept the market in surplus for years, are uncertain in the future, and the potential for labour strife could limit output from the second-largest producer, South Africa.

"The auto sector looks pretty good; supply from Russia is less a drag on prices; and substitution between platinum and palladium favours palladium," said Jeremy Friesen, commodity strategist at Societe Generale in Hong Kong.

LARGE INVENTORY MAY WEIGH

However, the residual supply surplus from previous years has created a large stockpile of palladium.

"There is a large amount of above-ground stock in the palladium market ... which is ultimately held by speculators, investors, possibly some industrial users," Jonathan Butler, publication manager at refiner Johnson Matthey, said.

The palladium market balance since 1980 shows a cumulative surplus of nearly 10 million ounces, he said.

Producers are well hedged, which means they will not need to purchase new material from the market immediately, he added.

Any price uptick is also likely to stimulate the rate of recycling.

"With a sustained increase in platinum group metal prices in the next 12 months, we would expect to see collectors release some of the inventory they hung onto in 2012," Butler said.

Net long positions in U.S. palladium futures and options struck a record high of 18,379 contracts in the week ended Dec. 31, nearly triple that of two months earlier.

That, combined with an all-time high in total open interest of 32,293 contracts, suggests that palladium could face a pullback as investor sentiment is extreme and ready to reverse.

Despite these headwinds, palladium's underlying story still is strong enough to convince investors that the metal is a good bet. And their buying is likely to buoy the price.

"With the existing inventories and hedges, the theoretical supply and demand figures are not really relevant," one trader said. "(But) the market can easily go up to $800 as long as speculators and ETFs are buying."

(Reporting by Jan Harvey and Rujun Shen; Editing by Veronica Brown and Jane Baird)