Glencore’s Interests Line Up With Long-Term Zinc Growth

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You can’t say Glencore isn’t doing its bit to cut global overcapacity in base metals and bring the market into balance – although you shouldn’t mistake its actions for an altruistic motive, this is purely self preservation.

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Following a recent announcement that the firm would close copper mines in west Africa for 18 months, the markets reacted. “Glencore to cut annual zinc production by a third” was this week’s headline in the FT.

That amounts to half a million metric tons of annual capacity out of Glencore’s forecast of 1.54 mmt this year and, prior to the announcement, 1.6 mmt next year. Around 100,000 metric tons will be lost from Q4 2015 as the firm closes their Lady Loretta mine in Australia, Isacaycrus in Peru and reduces output at George Fisher and MacArthur River in Australia as well. Various reports say some assets in Kazakhstan will also see output shrink.

Zinc is Glencore’s third-most important commodity for its industrial business and was expected to contribute about 14% of this year’s expected earnings before interest, taxes, depreciation and amortization (EBITDA).

The zinc market was expected to go into deficit earlier this year as 2 major mines were scheduled for closure, Vedanta’s 175,000 metric-ton-per-annum Lisheen in Ireland and MMG’s 400,000 mtpa Century in Australia, but rising exchange inventory suggests there is plenty of metal around and, indeed supporting that view, prices have continued to slide.

Set against such a backdrop, Glencore’s mine closures are significant in scope and have the potential if not to push the market into immediate deficit, at least set the stage for a tighter market next year and potentially firmer prices. The firm’s comments when making the announcements are interesting.

“The main reason for the reduction is to preserve the value of Glencore’s reserves in the ground at a time of low zinc and lead prices, which do not correctly value the scarce nature of our resources,” the company said in a statement.

Of course, another way of saying that is “we are losing money producing from these mines at this price and as part of our efforts to cut £30 billion of debt, we are shuttering any production that is not showing a positive return.”

Of course, they could have said that, but the actual wording illustrates the view of a management structure that both operates and owns the firm. All of Glencore’s senior management are also significant shareholders who have repeatedly shown they can take the long view in a way that conventional mining companies’ investors do not or cannot.

Daniel Maté, who owns just over 3% of the company’s shares, runs the zinc business for Glencore. In Glencore’s view, the managers like Maté own those assets in the ground and, as collectively major shareholders, for the management to say they will be worth more tomorrow than today is a perfectly valid reason to leave them there rather than dig them up. Even if you could turn a low margin on them at current prices.

It reveals the trader’s view of long-term value rather than the miner’s view of short term performance and, while there should be no doubt the firm is responding to the appalling slide in the share price, their comments suggest a confidence in the future that is supported by many of them buying more shares even as the price has fallen.

Analysts differ on the impact this move will have to zinc prices. Credit Suisse are quoted by the FT as saying: “Our current zinc base case is for a small deficit in 2016/17 but these cuts will potentially move the market to a large deficit and reduce global exchange stockpiles to below 2 weeks – a level that typically leads to materially higher zinc prices.”

Are we going to see a rally in prices? Once the initial reaction has passed, London Metal Exchange zinc jumped some 12% on the news, it is likely to fall back as the market waits to see what impact a reduction in mine output really has.

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Some point to massive off-market inventory as a dampener on the party. Glencore, itself, is credited in some quarters as being the seller of some 228,225 mt of metal that suddenly turned up in New Orleans last month. In the medium term, though, it will be supportive, particularly if it encourages a few others to join Glencore and at least temporarily shutter production during 2016.

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