Is Zinc All Set For a Bull Run? (Part 2)

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Read the first part of this article here

How can one offer caution against the bullish picture for zinc when faced with falling inventory and rising demand, not to mention the imminent closure of major mines suggests we are in for a supply crunch?

LME inventory may be down this year but at 1.1 million tons, it is still not far off the last record high set in 1994. Zinc’s last boom was in 2006, when prices touched $4,580/ton, but in 2006 stocks were equivalent to 2.6 weeks of consumption. Now they are about 10 weeks. Nor are the reported LME stocks the whole story. In fact, focusing on LME inventory may be masking the true scale of the current oversupply.

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As Andy Home analyzed in a Thompson Reuters report, zinc is experiencing the same distortion due to the stock and finance model that has perverted the aluminum market. Nearly 400,000 tons or over one-third of stock are sitting in New Orleans with just three firms managing the LME warehousing in town. Pacorini, owned by Glencore Xstrata,  has 34 of the 56 registered warehouses. Metro (Goldman Sachs) has 15, and Henry Bath (JP Morgan) has five.

Fortunately for zinc consumers, the very isolation of New Orleans from any major consumers means the physical delivery premiums for zinc have not been distorted to the same extent as aluminum. But the massive load out queues – nearly 300,000 tons in New Orleans alone – suggest that this metal is not heading for consumption but for storage off market at a lower cost. Much of the stock drawdown this year could be for storage off market rather than as is widely assumed for end user consumption.

That undermines the argument that falling LME inventory is a bullish signal. Reuters quotes analysts at Barclays Capital, saying off-market zinc stocks are reported to be extremely high both in LME locations and at producers in the form of consignment inventory. Their assessment, based on adjustments to the ILZSG consumption numbers, is that “unreported stock build could have been as much as 660,000 tons over the past 2.5 years.”

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The latest ILZSG figures show the global refined zinc surplus was 70,000 tons in the first seven months of this year, while the World Bureau of Metal Statistics puts it at an even higher figure of 128,000 tons in the first seven months. But there was a stark split between China, which was in deficit to the tune of almost 300,000 tons and the rest of the world, which was in 370,000 ton surplus.

Some of that surplus has moved to China. Net imports in the first seven months were 300,000 tons, suggesting not only that Chinese demand is strong but that save for Chinese demand, the market would be in an even worse state of oversupply. Why, though, is Chinese demand for refined metal so strong? Yes, the mini stimulus has boosted construction, as we noted earlier, but another reason is smelter refining (from concentrate to refined metal) is depressed at below 80% capacity utilization.

China is the world’s largest zinc producer and largest miner, producing about a third of mine production. More favorable treatment charges could see a pick up in domestic refining and a sharp drop in refined imports next year. If prices were to rise next year, it is likely the refiners would rapidly respond to the more favorable price environment and raise output. The capacity is there; it just needs a slight rise in prices.

So mine closures will reduce the surplus in concentrate supply over the next few years, and prices will rise to more sustainable levels from 2014 onwards. Almost everyone seems to agree with that trend, but a bull run for zinc? It is looking less likely than supporters would have us believe, as there is just more slack in the system than there first appears.

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