MI LME WEEK SPECIAL: Zinc still every bull's darling
Metals Insider - 09 October 2006
MI LME WEEK SPECIAL: When the metals community last descended on London for LME Dinner 2005 zinc was every analyst's favourite pick of the bunch for out-performance in 2006 and they weren't wrong.
The LME 3-month price closed last week valued at $3,590, representing a 143% year-on-year improvement from the $1,478 level seen this time last year. Even that comparison doesn't paint the full picture, though, because some lucky players sold the market as it was hovering just below the $4,000 level on May 11.
That was a time when the flood of fund money into the LME complex and the wider commodities complex probably reached its peak. The CTA systematic fund community and the index funds were joined by a rush of “hot money” in pursuit of what looked like a one-way ticket to sizzling returns on the industrial metals.
Those hot investment dollars have since ebbed away from the metals since that May orgy in a series of reverse flows resulting from a rising global interest rate environment—no more cheap money on which to leverage commodity plays—a falling oil price, deteriorating sentiment about global growth and the near collapse of the Amaranth hedge fund.
But the black-box CTAs are still in there as is the drip-drip of pension fund money being allocated for risk diversification into commodities. And zinc is still every analyst's pick of the bunch for performance in 2007.
Doing the Math
The reason it remains everybody's darling is two-fold. Firstly, copper, which led the pack higher in this part of the cycle now looks dangerously wobbly at its elevated heights, even if so far it hasn't actually broken lower. Sentiment in aluminium has been undermined by a negative chart picture and the collapse in the alumina raw material price. But zinc's time, it is argued by the bull masses, hasn't even truly arrived.
Which leads on to the second reason zinc is still the pick of the analysts' crop.
Visible inventory in the form of LME stocks fell by 235,000t last year and is down by 260,000t so far this year. The last big movement of those off-market stocks which so long plagued the market's fortunes took place back in June 2005, leading most to assume the disappearance of that off-market inventory cushion.
The International Lead and Zinc Study Group has just forecast the market (Western) to record a deficit of 354,000t this year and of 154,000t next year.
You don't have to be a rocket scientist to do the math about what that means for LME inventory levels in a year's time.
Market tightness has started to manifest itself in rising physical market premiums, even if the nearby structure of the LME contract remains in small contango.
Zinc seems set on a linear path towards critically low stock levels and the sort of technical market tightness experienced by both nickel and copper in the recent part of the cycle.
A One-Way Bet?
But is it really the one-way bet that is commonly assumed? Or, maybe that should be, is it still the one-way bet that has been assumed for over a year now?
How much future expectation is priced into a market that has already more than doubled in price in the space of the year WITHOUT critically low stocks? And can zinc continue rallying if the other LME metals stop rallying?
In principle the answer to the latter should be yes, even if the industrial metals complex and the wider commodities complex has been increasingly closely correlated in the last couple of years thanks to the big bank indices.
Sustained production-consumption deficit should continue eating away at those stocks and mitigate against price weakness. But we have three important caveats.
Firstly, there is little doubt that the US economy is already slowing and that will send a ripple effect through the global economy. Even if, like us, you believe that this will be a period of slowing growth rather than recession, it has implications for demand for all the base metals.
Secondly, it's unclear whether China—the key plank of the super-cycle theory of commodities, the “stronger for longer” argument—is going to play as big a role in zinc as in, say, copper and nickel. There is a strong feeling among analysts that China has de-stocked heavily of the latter two and will have to come back to the Western market in the form of higher imports at some stage soon in the cycle.
While China is now a net importer of zinc and zinc alloy, the country is not quite performing to bull market script. Net imports of refined metal were 15% off the pace of the year-earlier level over Jan-Aug and the country has twice this year flipped back to monthly net exporter.
It has been able to do so, it seems, because its refined production growth has doubled to 14% so far this year. By August the country had produced an extra 260,000t of metal relative to August 2005.
That in itself is surprising because China was perceived to be particularly vulnerable to the concentrates tightness which has underpinned zinc's rally from the start. But domestic mined production is growing at an even faster pace than the refined metal growth and we and others have suspicions that the official figures are not capturing even faster growth in the small unofficial sector.
The country's concentrates imports were running flat against year-ago levels through to July but they rocketed higher in August—134,000t bulk weight against 17,000t in August 2005.
Analysts are still scratching their heads about that particular bit of market data but it does look as if smelters have begun re-stocking with concentrates just as prices for the raw material come off the boil.
Which brings us to the third contrarian argument for zinc. As with copper and nickel, the bull argument rests on a deficit of metal coming out of the ground. The zinc concentrates market has been extraordinarily tight for some time now and has brought with it casualties such as the Big River zinc refinery in the US, which was closed earlier this year due to lack of raw materials.
But there is growing evidence that the concentrates market may be on the point of turning, or even already have turned, as is suggested by China 's buying bonanza in August.
New mines and restarts have only just begun to kick into the supply-demand equation but they will gather momentum over the next 12 months. That may still be too late to save the refined market from visible inventory falling to critical levels but there a full supply-side response to concentrates tightness marked out for the next part of the cycle—which is something that is patently lacking in either copper or nickel.
Note for example that Big River Zinc has been bought by ZincOx which intends to resume production using EADF feed. Well, that is unless Swiss trade house Glencore which has just bought the idled Tennessee mines from Asarco doesn't conveniently reopen them and start feeding the plant's primary circuit again.
Slowing global economic growth and rising mine production don't seem to be the right combination for zinc to stage another 100% rise in price over the next 12 months but having waited for so long to display the same sort of bull market fundamental credentials as its sister metals, zinc seems to be in no mood to leave the party right now. And we thought there was no such thing as a one-way bet in the financial markets…
Analysis – Longer term rangebound, but 3739 could come under pressure this week.
Weekly Change: +260 (+7.81%) All prices are from the previous business day's close .
Pivot: 3050 or 3739.
Preference: Zinc surged higher on Friday to break above 3529 and make a new 1 month high. In the shorter term the move above the short term MAs and 3529 is encouraging and we could see some pressure put on the top of the range. However, in the longer term the market remains rangebound between support at 3050 and resistance at 3739 and will continue to do so while these levels hold.
Alternative: A strong move outside of the current 3050 to 3739 range could help indicate future direction. A move below 3050 could still find support at 2810. A move above 3739 would indicate gains towards the all time high at 4000. (Michael Davies, Analyst, Sucden ( UK ))
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AIM Price at posting:
0.0¢ Sentiment: Buy Disclosure: Held
(20min delay)