Not so long ago, my colleague Stuart suggested too much steel capacity may have come online too quickly creating a potential double-dip in prices for steel producers.Ã‚Â I spoke to a metal-buying group in Western Michigan in mid-September and an audience member at the time shared with me “current capacity utilization rates vs. “historic capacity utilization rates to argue that steel shortages may become imminent because capacity utilization appeared extremely low from a historical perspective. I didn’t disagree with his numbers on capacity utilization, only the conclusions he drew that at current capacity utilization rates, steel shortages would ensue.
And now we see a very similar story playing out but this time in the world of zinc. When prices increase, producers ramp up production. But the question remains, what does the demand equation look like? In an excellent article on the behavior of base metals markets, a commentator under the pen-name of “Wildebeest (no comments from the peanut gallery please) made the case, rather effectively I might add, that the rise in base metal prices appears to have come primarily from speculators or investors looking for a safe haven against inflation and not (surprise surprise) from actual industrial demand. Well, we’ve been harping on that theme for the better part of this year.
Let’s flash back to September. Back then at that same speaking event in Western Michigan, we laid out two schools of thought on zinc. One school of thought put forward by HSBC suggested demand from the west would come on stream next year pushing zinc into a deficit situation. The other school of thought came from CRU who argued too much stock exists resulting in an overhang that could create a collapse in zinc prices. So let’s take a look at where prices have gone recently as well as what the stock situation looks like:
Okay, so we have stocks going up but prices also going up. Who is right? HSBC or CRU? We’ll attempt to answer that in a moment. But the collapse in prices has yet to occur. “The ILZSG (The International Lead and Zinc Study Group) is an association of producers, if they say the surplus is 300,000 tonnes read that as 900,000 tonnes minimum. For them to declare a surplus, things must be awfully wrong, said a London-based trader as quoted in this Reuters article.
So who has made the correct forecast? Our call; neither HSBC or CRU have zinc correct. We’d agree with CRU that the demand fundamentals look weak despite Japan posting very respectable automotive numbers. This month’s ISM report suggests the health of the US manufacturing economy appears to be deteriorating. We’d also agree with CRU that we have a zinc stock overhang. But we don’t think the price will collapse, (somewhat supporting HSBC’s price conclusions but not their rationale) not until the Fed moves interest rates up and the herd looks for alternative places to park its cash.
What you say? Demand does not support current price levels? Fundamentals have not played much of a role in terms of price. If we had a theme for 2009, that certainly would be it!