Zinc’s price performance has been disappointing in recent months. Zinc is one of the few base metals still trading in contango, which indicates good metal availability, resulting from large inventory levels, which is placing this base metal in a much less favourable position than the others. The contango has also encouraged fund short selling in zinc, which has caused additional price pressure and a deteriorating technical chart.
London Metal Exchange (LME) zinc stocks have continued to show hefty increases, which is in stark contrast to trends in other base metals. It does not mean consumption has been specifically worse than other base metals, but is rather a reflection of a shift in metal from large, unreported stockpiles to LME warrant. For medium-term price prospects, this is a positive development for zinc, but is why we expect zinc to be the last of the base metals to peak in this commodity price cycle.
The latest statistical release from the International Lead and Zinc Study Group (ILZSG) was also discouraging, showing a market in surplus of 56,000 tonnes in the first half of this year. Still, zinc mine output continues to grow at a relatively modest pace (up 4% year over year in the first half of 2004), and, with low global concentrates stocks, zinc’s raw material market remains tight. China continues to attract much of this material, with imports sharply higher in July.
While China’s domestic zinc demand remains very strong, improving operating rates at the country’s smelters are likely to keep exports of refined zinc to the Western World at healthy levels. A reduction in export-tax rebates at the beginning of the year helped reduce refined exports significantly, but more recently exports have picked up. However, low treatment charges, poor power availability and relatively subdued zinc prices are still a reality and in light of this, Huludao Zinc Industry had to postpone twice the restart of 50,000 tonnes per year of idled capacity. The company plans to ramp up to full capacity next year.
Other discouraging supply news came in the form of an announcement that
In contrast to zinc, galvanized steel prices have held up well during the summer months. Galvanized-steel sheet prices are enjoying the cyclical upswing in manufacturing activity, while zinc-price performance has lagged — depressed by this market’s large inventory overhang.
Major steel companies continue to paint a bright picture for their markets, driven by strong Asian demand. Comments from the world’s largest steelmaker,
In contrast to the other base metals, fresh short-selling has been a feature of the zinc market after the peak in the first quarter, not least evident in the diverging trends in LME open interest (rising) and prices (falling). The deterioration in the technical trend and a contango market specifically encouraged CTA funds to enter short positions.
This also means that once fundamental prospects improve, this market should benefit from an additional push higher on fund short-covering.
Zinc turnover reached 935,000 lots in June, the highest since October 2003, before falling to 774,000 lots in July, representing the lowest monthly trading volume in LME zinc so far this year. This translates into a decline of 17.2% month-over-month and 26.6% year-over-year.
Even so, zinc remains the third-most actively traded base metal.
The contango in the zinc forward curve has steepened over the past couple of months. In line with further increases in LME warehouse stocks, the shape of the curve suggests ample metal availability over the coming 26 months.
Zinc treatment charges (TCs) remain around historically low levels and Chinese spot business is conducted around US$90 per tonne. Despite these low TCs, there are no signs of Chinese concentrate demand slowing, with imports in July alone surging to above 100,000 tonnes.
As for many of the other base metals, physical premiums for zinc in the U.S. are under particular upward pressure. The trend in European zinc premiums is similar to other base metals, too, with their relatively stable level reflecting the lack of an immediate rush for material.
In contrast to all other base metals, zinc inventories remain at a high level — around 740,000 tonnes at the end of August — and have failed to show any meaningful drawdowns so far this year.
Although strong physical premiums in the U.S. signal robust demand, this is not evident in LME stocks, with U.S. warehouse locations remaining the dominant holder of LME zinc.
Cancelled LME zinc warrants remain around 30,000 tonnes, or only about 4% of the remaining total, which suggests there are still no significant amounts of zinc awaiting outward delivery.
As a result, total reported stockpiles (including stocks at the LME, producers and consumers) also continue to rise. And the latest statistics from the ILZSG for June show producer and consumer stockpiles of zinc stand at about 295,000 tonnes and 115,000 tonnes, respectively.
Despite rising inventories, zinc’s stock-to-consumption ratio has fallen to about 8.2 weeks, down from its recent peak of 8.7 weeks in the fourth quarter of 2003, helped by a pick-up in consumption.
Trade data from China suggests exports of refined zinc remained at extremely subdued levels in July compared with last year (down 68% year-over-year) at 6,800 tonnes, and that net exports were a massive 95% year-over-year lower in the January-July period.
However, imports of zinc contained in concentrate have picked up sharply in July, to 104,000 tonnes, up by 73% year-over-year. This raises the prospect of better operating rates at Chinese smelters going forward.
The global, refined-supply surplus in zinc widened to 34,000 tonnes in June, leaving the surplus of the first half of 2004 at 58,000 tonnes, compared with a 41,000-tonne surplus in the first half of 2003, according to the ILZSG.
Global mine output remains relatively subdued, rising 4% year-over-year in the first six months of 2004, with even lower growth rates in more recent months. However, we understand Chinese concentrates output is widely underestimated, explaining healthy Chinese growth rates in refined output despite concentrate shortages.
Global refined zinc consumption was up 2.6% year-over-year in the first half, rather modest after a 7.1% year-over-year jump in April. Although total reported stocks were down 40,000 tonnes during the first two quarters of the year, concerns over large unreported stockpiles still dent the upside in prices.
Lead
Lead prices remain not far from recent peak levels of above US$900 per tonne (for the 3M contract), supported by extremely low levels of refined inventories. Unusually, lead cash prices even exceeded prices of sister metal zinc at one point at the beginning of August. Lead price prospects for the remainder of this year continue to look strong, in our view, driven by low availability and an expected pick-up in winter battery demand during the fourth quarter.
LME lead stocks have fallen consistently through this year to their lowest since 1990, with only 30,000 tonnes available to the market at the end of August. Drawdowns at U.S. warehouse locations have been particularly sharp, with strong physical premiums reflecting a very tight regional market, and producers are reportedly struggling to meet customer requirements.
Supply and demand statistics from the ILZSG confirm tight market conditions, reporting a global supply deficit of 22,000 tonnes in the first half of 2004. However, the data also suggest global mine supply has started to pick up (up 10% year-over-year in the first half) in response to high prices and robust demand. Strong Chinese import demand of concentrates has ensure
d treatment charges remain at historic lows, but also enabled healthy growth in domestic refined lead production, with a pick-up in refined lead exports evident in July.
The latest demand data from the Battery Council International (BCI) show North American shipments of replacement batteries (which account for the largest share of lead acid-battery demand) rose by 6% year-over-year in the January-April period to 28.3 million units. And Chinese exports of lead-acid batteries accelerated in July, according to customs statistics. For the period January-July, exports of industrial batteries and SLI were 57.4 million units (up 29% year-over-year) and 9.7 million units (up 0.1% year-over-year), respectively.
In supply, Glencore’s reopening of Porto Vesme is likely to add about 60,000 tonnes of refined lead to the market this year, compared with last year’s output of 78,000 tonnes. In other supply news,
Treatment charges accepted in Europe and China continue to differ sharply, partly because of large freight differentials.
Higher mine production in the first half as reported by the ILSZG is not yet evident in treatment charges, with significant Chinese demand for concentrates depressing spot TCs around US$45 per tonne.
On the LME, the sharply falling trend in open interest has stabilised in line with a pause in the upward price trend.
The inverse relationship between open interest for lead futures and prices, particularly during the first quarter, suggests the price was driven higher by a strong physical market, with short positions covered on the LME against physical deliveries.
Since then, there has been evidence of fund long liquidation, particularly during the second quarter, in line with profit-taking in other base metals.
In June, lead turnover on the LME reversed its falling trend briefly, rising 23% month-over-month to 339,800 lots, before dipping again to 312,800 in July. This reflects a 7.9% drop month-over-month and a 34.2% decline year-over-year in July.
Interest in trading the metal has been weakening consistently through the year amid sharply rising prices, evident from the fall of 72,900 lots traded since the start of this year.
The change in the lead forward curve over the past couple of months is worth noting, with a less pronounced backwardation now evident. Higher prices far beyond the forward curve suggest consumer buying has outpaced producer selling, while softer nearby prices partly reflect profit-taking by funds.
The cash-to-three-month lead price spread tightened to a US$150-per-tonne backwardation at the end of July — the largest backwardation we have on record. A few metal deliveries were attracted to LME warehouses at the time, but only small volumes.
By the end of August, the backwardation had eased to about US$50 per tonne again, which was the average in June.
Physical lead spot premiums have continued to improve in all key lead consuming regions, despite a seasonally slower period, pointing at robust underlying demand and limited supplies.
With primary lead inventories critically low and an expected pick-up in winter battery demand through the fourth quarter, we expect premiums and prices to remain firm during this period.
Notwithstanding a few recent deliveries into European and Asian warehouses, LME lead stocks are very low in all major warehouse locations, at around 37,000 tonnes in August.
Since the beginning of this year, U.S. LME lead stocks have fallen from a peak of 126,000 tonnes to less than 20,000 tonnes, leaving prices well underpinned.
Data for cancelled LME lead warrants suggest even more metal is about to leave LME warehouses. Although having fallen to only 5,000 tonnes in August, from the peak of 30,000 tonnes early this year, cancelled lead warrants still represent about 15% of the remaining total.
We estimate total reported lead stockpiles (including those at Exchanges, producers, consumers and merchants) are now at their lowest levels we have on record (dating back to 1984), at about 315,000 tonnes.
The ILZSG reported producer and consumer stockpiles of lead stood at 130,000 tonnes and 145,000 tonnes, respectively, at the end of June.
Because of sharply falling inventories, stocks measured as weeks of consumption are now only 3.3 weeks, which is also the lowest we have on record. This compares with its most recent peak of 5.2 weeks in the second quarter of 2002.
Chinese monthly trade statistics show net exports of refined lead were 10% higher year-over-year in July, at 34,000 tonnes, but still 1.2% year-over-year lower in the first seven months of this year.
As with zinc, imports of lead-in-concentrates were also sharply higher, at 109,300 tonnes in July (up 127% year-over-year), raising the prospect of higher Chinese refined output going forward.
Data from the ILZSG show global lead mine output has risen 10% year-over-year in the first half in response to the high price environment and healthy demand, although total refined output was only 2.4% higher over the same period.
With refined consumption growing 2.5% year-over-year in the first half of 2004, the global market remains tight, registering a 22,000-tonne deficit in the first half, compared with a 18,000-tonne deficit in the same period last year. However, most of the tightness was concentrated in the first few months of this year.
— The opinions presented are the authors’ and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the authors at kevin.norrish@barcap.com and ingrid.sternby@barcap.com
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