Encouraging signs for zinc and lead

Zinc

After two years of depressed zinc prices in a narrow range, the price peak of US$877 per tonne in August shows an encouraging ability by this market to finally move. Stronger prices are fundamentally justifiable in our view, and we expect another test of these higher levels over the near term.

The supply-and-demand imbalance has improved markedly during the first half of this year, with the large surplus in 2001-2002 eliminated through reduced production. A more positive macro-economic outlook likely will benefit the future price trend, especially as the ability to raise output in a rising price environment is limited, owing to the fact that relatively little mine capacity is idled. Recent corporate activity has also been of interest, with Finland’s Outokumpu acquiring 49% of Sweden’s Boliden (bls-t), in return for assets, which increases the concentration among the world’s top miners and, in theory, improves the ability to respond to changing demand and price conditions.

Developments in China remain key to the zinc market, and we regard nearer-term prospects as positive, while China is likely to pose a threat further out. For now, Chinese consumption is strong and production constrained, restricting large-volume exports to the Western World, especially as London Metal Exchange (LME) prices remain relatively unattractive relative to domestic prices. On a longer-term negative note, smelter capacity utilization is low in China (less than 80%). As concentrates become more available and LME prices and treatment charges improve, Chinese refined output should grow quickly.

In fact, there are already signs of some re-start of Chinese refined production. Baiyin has plans to restart its 147,000-tonne-per-year Northwest zinc smelter in the fourth quarter after a 7-month shutdown, owing to tight concentrate and power availability and low LME prices. In contrast, Huludao has no intentions to restart its 130,000-tonne-per-year smelter before the end of this year.

Changes in Chinese tax rebates in 2004 could become a key issue for the zinc market; a value-added-tax rebate of 15% on all zinc exports has been in place since 1998. We believe the State Council is considering two possibilities: either to abolish the tax rebate entirely or just reduce it to 11%. Although still an uncertain issue, a reduction is likely to discourage refined exports.

As opposed to most other LME metals, zinc inventories have continued to build during the third quarter. Total reported inventories are at their highest level since 1996, with the LME stockpile 55,000 tonnes higher, compared with the beginning of the year. Given that almost 400,000 tonnes per year of refined zinc capacity has been removed from the market so far this year (mainly in Europe), we expect a reversal of the rising inventory trend next year as the market moves into deficit.

Steel sheet prices have remained under pressure in the Western World, while they remain robust in Asia. Prospects for the remainder of the fourth quarter are mixed, but steel sheet prices in the United States and Europe could at least stabilise, or even rise, for economic conditions have improved.

As with the other base metals, LME open interest for zinc and prices have been closely correlated lately, suggesting that market participants are acting from the long side. Simultaneously rising prices and open interest suggest investors are buying fresh long positions.

Zinc was the third most heavily traded metal on the LME in August, with a healthy 974,300 contracts traded. While this represented a month-over-month decline of 7.7%, the year-over-year figure is more impressive: it jumped by 56.7%. As a result, the month was the most active August for zinc in the past five years.

At the end of the third quarter, the zinc forward curve was trading in a full contango, suggesting good metal availability over the next 27 months. However, as we expect the zinc market to move into deficit next year, tightness likely will increase along the curve. As a result, we believe current forward prices provide a good buying opportunity, as they have been trading at a discount to our future price projections.

While remaining tight overall, the zinc concentrates market has eased a little recently, as new material has become available, partly from Teck Cominco‘s (tek-t) Red Dog mine, as well as fresh spot sales from Noranda (nrd-t). European smelter closures have released some feed, which is finding its way primarily to Chinese smelters. Concentrate inventories are still low; as fresh material is absorbed quickly, treatment charges likely will remain subdued.

European physical premiums have remained strong, because of smelter closures during the first half of the year and falling regional inventory levels. Generally, U.S. and Asian spot premiums eased in the first half of 2003, though they show some signs of stabilizing.

LME inventories either have continued to rise or have remained stable and firm in the main warehouse locations. The U.S. continues to hold most of the stockpiled material, at almost 350,000 tonnes. In light of European capacity closures, inventories in the region are relatively less burdensome.

Zinc inventories remain troublesome for significant price gains because they remain substantial. In contrast to most other base metals, LME inventories have continued to rise this year, with stocks now about 55,000 tonnes higher since year-end (+8.5%). At the same time, cancelled LME warrants are relatively low (about 18,000 tonnes, or 2.5% of the total remaining stockpile), which suggests that the upward inventory trend may not start to reverse just yet.

The trend in total reported inventories is the same as for LME stocks. The total stockpile now has risen to its highest since January 1996, at 1.1 million tonnes. Western World capacity closures, strong Chinese demand, and improving Western consumption eventually should help reverse the rising inventory trend.

As inventories have risen to their highest level since the mid-1990s, total stocks measured as weeks of consumption now stand at 8.5 weeks, also representing the highest level in eight years.

Chinese net exports of zinc remain subdued, and the possibility of a lower tax rebate ahead could help restrict large-volume exports further. In July, net exports amounted to 21,100 tonnes, which is 30% below last year’s level for the same period. Net exports for the first seven months of the year were not even half of last year’s levels, at 122,000 tonnes.

Statistics from the International Lead and Zinc Study Group show fundamentals continuing to move in favour of prices. The data confirm that concentrates availability is tight, with mine output subdued in July, which also helps restrict refined production. While largely still driven by China, the global consumption trend has been positive: +7%, year over year, in the January-to-July period. As a result, the global zinc market registered a modest surplus of 36,000 tonnes in the first seven months of this year, compared with a sizable surplus of 219,000 tonnes a year earlier.

Lead

Lead is a smaller contract on the LME, and hence tends to receive less attention than other LME base metals. Still, the lead market’s liquidity is often greater than for both nickel and tin. From a supply-and-demand perspective, lead is also slightly different from the other base metals. Much of the total supply is derived from secondary material, while demand is relatively less sensitive to economic growth, with replacement batteries representing a majority share of total demand. Total annual lead tonnages consumed are in fact four times larger than nickel and 22 times greater than tin.

Since the cyclical commodity price trough in the fourth quarter of 2001, together with its related metal zinc, lead has underperformed the rest of the LME complex. With significant supply reductions during the first half of this year, the outlook now looks healthier, with strong support from China. Meanwhile, a revised report from the U.S. Battery Council International (BCI) showed North American shipments of replacement automotive lead-acid batteries declined 7%, month over month, in December 2002, but rose 3% in 2002 as a whole.

The possibility of positive implications from a capacity closure in the U.S., along with other constructive developments in the lead market, keeps the price well supported above US$500 per tonne. U.S. producer Doe Run announced the suspension of production at its 137,000-tonne-per-year Glover smelter in Missouri. The suspension is primarily due to weak U.S. demand in the wake of loss of market share in the (replacement) battery sector to China. Unless the company’s mining operation is also hurt by lower production, the global refined market balance is unlikely to be markedly affected. Concentrates from the company’s mine will most likely be diverted to its other smelter, the 230,000-tonne-per-year Herculaneum plant, which is currently operating at only around 50% of capacity. However, the company added that it will regularly evaluate market conditions. There is a possibility that the mining operation could also face output reductions and that the Herculaneum smelter might not ramp up as quickly as the market expects. This would have a supportive impact on prices, while U.S. physical premiums are most certainly likely to rise in the meantime.

In other corporate news, Swiss-based Xstrata says it intends to close its Northfleet lead recycling plant in the U.K. by year-end, which is likely to remove roughly 36,000 tonnes per year of lead from the global market. This can be added to the 60,000 tonnes withdrawn on the back of the closure of its number-two primary lead refinery at the Northfleet complex earlier in the year. Britannia (a wholly owned subsidiary of Xstrata) confirmed at the same time that it does not intend to close its number-one 180,000-tonne-per-year lead refinery at the complex, which receives its feed from the Mount Isa mine in Australia. The closure is further evidence of tough operating conditions in light of European currency strength, and low primary prices and treatment charges.

Lead treatment charges (TCs) have remained stable and low, at around US$98 per tonne spot in August, even though a significant number of smelters closed. This reflects an extremely tight concentrates market still, with the main activity in China. Chinese lead concentrates imports have continued to rise; they stood at 288,200 tonnes in the first seven months of the year (+70%, year over year). Chinese concentrates demand is likely to remain strong and keep TCs low until more concentrates become available.

LME open interest for lead and prices have been closely correlated lately, suggesting that fresh buying (of long positions) has helped push lead prices higher.

Of all of the LME’s major metals, lead showed the greatest expansion in year-over-year trading volumes in August, expanding by some 61.3%, a rise that corresponded with the rapid price gains seen during the month. Despite these gains, lead remained only the fourth most actively traded metal on the exchange, with some 439,000 contracts changing hands during the month.

Despite some nearby tightness in recent months, and signs of the whole forward curve is flattening, the full contango returned again at the end of the third quarter. As the market balance tightens, we would expect renewed upward pressure on cash prices as demand for prompt delivery improves. Producers should also be aware that far forward prices are unlikely to rise at the same pace as nearby prices, while consumers consider the fact that current forward prices are trading at a discount to our future price projections.

With recent statistics showing a global lead market in deficit, the cash-to-3-month contango is now considerably less pronounced than it was at the same time last year. With signs of changes in the whole forward curve, the nearby spread has been trading in only a small contango (about US$2-3 per tonne).

Following capacity closures in Europe earlier in the year, regional inventory levels have declined while premiums have continued to rise — now exceeding U.S. premiums for the first time in recent memory. As much of the world’s battery production is shifting to the Asian region (China), Asian premiums have risen to all-time highs. U.S. premiums remain choppy, largely for seasonal reasons, but are likely to remain supported, owing to reduced production at Doe Run.

Swedish inventories are now depleted, and Europeans have to rely on material held in Italian warehouses, which are also low on stocks. Asian inventories have continued their downward trend, which has been in place all of this year, signalling strong demand in the region while battery production is on the rise. U.S. demand remains slack, but any further warehouse inflows have been modest, possibly signalling a reversal of the up-trend in inventories while the supply side gets tighter.

While fluctuating widely over the past year, cancelled LME lead warrants have now fallen to almost zero. This signals that there is now little material awaiting outward shipment. Although the total LME lead stockpile remains substantial (just below 160,000 tonnes), there is evidence of a downtrend starting to emerge, with stocks recently about 26,000 tonnes lower than at the beginning of the year (or -14%).

Measured on a total reported basis, lead stocks stood at an estimated 464,000 tonnes at the end of September. Inventory drawdowns have been most pronounced on the LME since the beginning of the year, while producer stocks are also at a lower level over the same period (at 148,000 tonnes). Consumer stocks have risen by 13,000 tonnes, to 53,000 tonnes, since the beginning of the year, according to data from the International Lead and Zinc Study Group.

Since the recent peak at 5.3 weeks in the second quarter of 2002, the lead stock-to-consumption ratio has fallen to 4.7 weeks, at least at the end of the third quarter of 2003. A declining inventory trend and strong demand (particularly in China) is likely to keep total reported lead stocks measured as weeks of consumption at a declining rate for the foreseeable future.

Chinese net exports to the Western World remain relatively subdued compared with last year’s levels. July exports amounted to 30,600 tonnes, while exports for the January-to-July period were 237,000 tonnes, representing a level 2% lower, year over year. A new tax rebate could have positive implications for Chinese net trade. China will gradually reduce tax rebates to exporters from next year to 11% from 15%, as well as eventually cancel the rebates from 2010. Lead would be one of the first five export commodities to lose rebates completely.

The global lead market registered a sizable, 81,000-tonne deficit in January-to-July, compared with a 101,000-tonne surplus in the corresponding period of 2002. Concentrates availability remains low (mine output was subdued in July at 241,800-tonne, equivalent to -1.3%, month over month, and +1.3%, year over year. However, global refined production fell sharply to 531,900 tonnes (-8.7% month over month). At the same time, the global consumption trend remains positive, driven by China.

— 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