METALS COMMENTARY
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But although prices climbed above US$1,400 per tonne in March (the highest level in almost eight years), they were also hit by fund long liquidation, causing them to fall back about US$100 per tonne. Apart from previous price gains, liquidation was encouraged by the persisting contango in the front-end of the forward price curve, derived by still-high inventory levels. After this correction, zinc provides a good opportunity for those looking to buy, in our view, as its fundamentals continue to improve. We see further substantial upside potential in prices, our forecast being US$1,500 per tonne.
Our positive view of zinc prices is based on both supply and demand trends. On the demand side, China is undoubtedly the key driver, where zinc demand continues to be boosted by large galvanized steel expansions in response to large fixed asset investments and construction activity. Following an extremely strong fourth quarter in 2004, Chinese galvanized steel production has continued to expand: the latest data show output was up 60%, year over year, in the first two months this year. China has now overtaken both Germany and South Korea to become the world’s third-largest producer of galvanized steel, after the U.S. and Japan.
While demand conditions for zinc have also stayed strong in other parts of Asia, U.S. demand has weakened and European demand conditions have been mixed. This is consistent with anecdotal evidence of softer order books in the U.S. and a build-up of unreported stockholdings of zinc in recent months (albeit reportedly not all deliverable to the LME). Although unreported stocks have been massively reduced over the past year, the general market view is that there could still be up to 80,000-100,000 tonnes of zinc off-warrant.
Strong Chinese demand has had an important impact on the global zinc market. After being a significant net supplier of refined zinc to the Western World in recent years, China is repositioning itself as a net importer. In the first three months this year, the country’s net imports rose to a significant 50,000 tonnes, compared with large net exports in recent years.
Apart from strong domestic demand, supply-side developments have also contributed to China’s becoming a net importer of refined zinc. Its smelting business is running well below capacity (maximum 80%), dampened by two key factors. The first is acute shortages of raw material feed, and the second relates to the lack of power and resulting high energy costs. Spot treatment charges have fallen to as low as US$65 per tonne (basis: US$1,000 per tonne), pointing to extreme tightness of zinc concentrates.
The result of all of this is falling LME inventories, which are now down about 70,000 tonnes since the beginning of the year. And given current supply shortfalls, we expect total zinc stocks will also have fallen to critical lows (of five weeks) by the end of this year.
With extremely low inventory levels, the lead market is the tightest of all base metals, and we expect prices to stay pressured to the upside during the remainder of the second quarter, with battery demand supported as the U.S. driving season kicks off.
Lead prices are trading at around their highest levels in 15 years. Some attribute the sharp price rise to a weaker U.S. dollar and speculative buying. It would be wrong to say that these factors have not contributed to higher prices, but it has not been the key to the surge in lead prices. Low investment in mine production (leaving the concentrates market extremely tight), coupled with strong demand driven by Chinese battery manufacturing, has been the fundamental features underlying the price rise. The low level of LME open interest against a backdrop of rising prices suggests speculative length is, in fact, modest.
Indeed, weakness of the dollar together with low treatment charges have made European lead smelting activity unprofitable and caused closures in recent years. Today, spot treatment charges are rising toward US$130 per tonne (from US$100 per tonne at the beginning of this year), and the first term contract settlements have reportedly been agreed for 2005 between US$140 and US$150 per tonne (albeit on a different price basis) on better availability of concentrates. The Magellan mine in Australia is starting up and is expected to produce 66,000 tonnes this year.
Better availability of concentrates has enabled Chinese refined lead production to continue to grow (17% higher, year over year, in January-February) and satisfy robust domestic demand. A strong growth area of Chinese lead demand is lead-acid batteries on electric bicycles, a sector estimated to have consumed 60,000 tonnes of lead last year. In addition, the outlook for replacement battery demand is also positive, as lead-acid batteries in China typically have much shorter lives than in other developed countries.
Chinese exports of refined lead slowed in the first quarter, which provides further evidence of strong domestic demand, given higher domestic output. U.S. lead demand is also strong, driven by the industrial battery sector, notably from the telecommunication sector. Encouragingly, there are reports that battery manufacturers are increasingly able to pass on higher input costs to their customers.
Because of these positive demand trends, LME stocks continue to draw on a consistent basis, with total LME stocks now at only about 30,000 tonnes. And on a total reported basis (including stocks held by producer, consumers and merchants), lead’s stock-to-consumption ratio has fallen to only 2.8 weeks, which is below what is considered the “critical” level for lead (around three weeks). This leaves prices extremely vulnerable to another spike higher.
— 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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