ZINC looks set to rally from here By Sneh Mankani Zinc prices...

ZINC looks set to rally from here

By Sneh Mankani

Zinc prices continued to rise in 2006, bolstered by strong demand, supply constraints and the continued draw down of stocks. Prices increased 137 per cent year on year to average US$3250 a tonnes in 2006 and are forecasted to rise another 9 per cent to average over US$3550 a tonnes in 2007 as demand continues to expand faster than supply.

Total zinc stocks held by consumers, producers and in London Metal Exchange (LME) warehouses fell to 500,000 tonnes by the end of 2006, equal to 2.3 weeks of consumption and the lowest since 1991. Global stocks are expected to fall further in 2007, as consumption exceeds production, but are projected to increase over the medium term to 2.6 weeks of consumption by 2012.

One uncertainty in the outlook for prices is the potential for zinc production in China to be substantially higher than anticipated. The majority of zinc mine production in China is sourced from relatively small mines, with between 10,000 and 20,000 tonnes capacity, which have relatively short lead times to start up. Production from these small mines is highly responsive to prices, and hence, if prices remain high for longer than, say two or three years, more of these mines may begin production, resulting in significant additional supply.

Demand

Zinc Consumption Increasing

Global consumption of zinc grew by 3.4 per cent to 11 million tonnes in 2006 and is forecast to grow a further 4 per cent in 2007 to 11.45 million tonnes. Over the medium term, growth in consumption is projected to average 4 per cent a year, bringing world consumption of zinc to 14 million tonnes by 2012.

Data from the International Lead and Zinc Study Group show that galvanised steel currently accounts for about 50 per cent of zinc consumption. Galvanising (zinc coating) protects steel from corrosion and can increase the life of the steel by at least 500 per cent. Approximately 35 kilograms of zinc are used per tonne of galvanised steel sheet. The largest two consumers of galvanised steel are the construction industry and the automotive industry.

Galvanised steel is used for applications such as sheet roofing, car bodies and housing construction frames. The demand for zinc is therefore highly responsive to movements in the residential construction and motor vehicle manufacturing industries. Other uses of zinc include the production of zinc-based alloys such as brass and bronze, used in the manufacturing of household appliances, rubber and pharmaceuticals and in the purification of water.

China and India to drive consumption growth

China is the world’s largest producer and consumer of zinc. In China, zinc is used principally in the country’s growing steel industry for galvanising and as China’s steel industry expands, its demand for zinc will continue to rise. The majority of the increase in demand for galvanised steel in China is expected to come from the construction and manufacturing sectors. Construction growth driven by rural–urban migration in China is projected to flow through to growth across a range of major infrastructure developments. Building construction itself and the additional infrastructure required to service this construction will require large quantities of galvanised steel.

Strong growth in industries such as motor vehicle manufacturing is also increasing the demand for zinc. As incomes in China rise, local demand for cars is rising rapidly. China is now the world’s second largest market for new vehicles after the United States, with new vehicle sales reaching 7.22 million in 2006. Production and sales of cars grew by 25 per cent and vehicle exports more than doubled in 2006.

Increased infrastructure development is a main driver of demand for galvanised steel in India. The steel is used in many structural applications such as bridges, electricity transmission towers, utility poles, roads, railways, ports and refineries. India’s current focus on improvements to road, rail and electricity transmission and distribution infrastructure is expected to lead to strong growth in the production of steel in India and hence in the demand for zinc.

The growing demand for motor vehicles in India is also emerging as an important driver of the demand for zinc. Passenger vehicle sales in India rose by 20 per cent in 2006 and sales of multipurpose and utility vehicles grew by 16 per cent and 12 per cent respectively. Increases in vehicle demand are projected to continue as incomes rise in India, increasing global zinc consumption over the medium to long term.


China has turned a huge net importer of zinc concentrates with consumption showing no signs of abating

Unlike aluminium where demand is not just from China, zinc has remained a pure China story. In 2005, while global consumption grew by 238,000 tonnes, Chinese consumption grew by a whopping 458,000 tonnes. Between 2000 and now, China has accounted for 95% of the incremental growth. With China devouring 26% of the global zinc consumption, it remains the key driver of rising demand for the metal.

China’s galvanized steel production stood at just 4% of the global number but accounted for 24% of the global growth between 2000 and 2005. The country is cutting back on exports, and has turned a huge net importer of zinc concentrates. And Chinese consumption shows no signs of abating; conservative estimates indicate that the country’s zinc consumption would grow at over 15% per annum over the next few years. Chinese zinc exports are increasingly decelerating with more of the metal being used for domestic consumption.

Construction expenditures in China to increase 8.8% annually through 2011

Construction expenditures in China are forecast to increase 8.8 percent annually through 2011 to ¥6.4 trillion in real (inflation- adjusted) terms. An ever expanding domestic economy, continuing endeavors to upgrade infrastructure, sustained strength in foreign investment funding, healthy demand for Chinese manufactured goods, and further population and household growth will all work to drive construction market gains in China. China's demand for slab zinc is expected to grow 9.5% this year and about 9% next year.
Modest demand growth in the United States and European Union

There is a growing trend toward the use of galvanised steel in housing construction in the United States, where housing has traditionally used timber frames and rising timber prices have made galvanised steel an attractive substitute for construction. However, a downturn in the housing industry in the United States is expected to flow through to lower zinc consumption in 2007.

Housing permits in the United States (typically useful indicators for future construction activity) in December 2006 were 24 per cent lower than at the same time in 2005. Although US housing construction is likely to slow in 2007, it can be expected to recover over the balance of the outlook period and contribute to US zinc consumption.

Over the medium term, the consumption of zinc in the steel and motor vehicle manufacturing industries in both the United States and the European Union is projected to remain relatively constant (the majority of zinc demand is driven by developments in these industries). The combination of increased competition from China’s steel industry and a downturn in motor vehicle manufacturing, particularly in the United States, is projected to result in flat or declining consumption of zinc in both regions.

Supply

Production to increase from late 2007

World zinc production grew by 4.7 per cent to 10.7 million tonnes in 2006. An additional 640 000 tonnes of zinc metal is forecast to be produced in 2007, enabling a 6.3 per cent rise in total output to 11.5 million tonnes.

The increase in global production will come from a number of mine expansions and new projects that, in turn, reflect growing exploration budgets in recent years. Exploration expenditure tends to track prices quite closely and as prices have risen, global exploration expenditure has increased. Global exploration budgets have increased by approximately 150 per cent since 2002 when expenditure dipped below US$2 billion.

Increases to supply are expected to come on line progressively over the medium term. The increases in exploration expenditure that have occurred from 2003 onwards are expected to begin delivering increased output later this year.

For example, San Cristobal in Bolivia (capacity of 167 000 tonnes a year) and Cerro Lindo in Peru (capacity of 110 000 tonnes a year) are both due to be commissioned in the third quarter 2007.

Over the medium term, four large confirmed projects in Canada, Mexico, the Russian Federation and Indonesia are projected to come on line adding an extra 700 000 tonnes to global capacity. In addition to this, a number of smaller projects, amounting to at least 400 000 tonnes of zinc, are also expected to be completed. This increase in capacity, combined with the new projects and expansions in 2007, is projected to result in world production of zinc reaching 13.9 million tonnes by 2012.

Zinc inventories are at a multi-year low

From 610,000 tonnes in June 2005, inventory position is now down to 70750 tonnes Zinc LME stock inventories have been depleting on a daily basis over the last 15 months. From around 610,000 tonnes in June 2005, inventory position is now down to 70750 tonnes – the lowest level in terms of stock to consumption ratio and equivalent to 2.3 days of consumption period. Given this backdrop, minimal supply disruptions have had a magnified impact on prices.

To my mind, we are approaching the point of maximum market tightness in the current cycle for zinc. New and restarted mine capacity is gradually building momentum towards over-supply in the concentrates market. And that will gradually filter through into the refined metal market. But not just yet. Until it does and unless China’s trade flow switches suddenly, back to exports—not expected in the very short term—LME stocks are going to have to make good the shortfall.

Demand Drivers:
1. Global “synchronicity” of economies
2. Asia’s strong GDP & IP growth rate.

Supply Drivers (Restrictions):
1. Higher barriers to entry due to global environmental and governmental regulations
2. Long lead-time from exploration to production
3. Geopolitical events

Zinc is still dragging its feet and remains under pressure as the physical market is well supplied. This is the result of earlier exports/de-stocking from China, but as they now ease back, the market is likely to have to call upon the metal in LME stocks more.