July 2, 2018 / 12:58 PM / 2 months ago

COLUMN-Why China's lead producers aren't talking about output cuts: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

* Shanghai lead: tmsnrt.rs/2NiUfvp

By Andy Home

LONDON, July 2 (Reuters) - Last week’s call for coordinated production cuts revealed the margin pain being suffered by China’s zinc producers.

Conspicuous by its absence was any similar statement of intent to cut lead output, even though many of the zinc producers attending the meeting in Shaanxi province are also lead producers.

That’s down to a sharp divergence in price performance between the two so-called “sister metals” in Shanghai.

While the Shanghai Futures Exchange (ShFE) zinc price has tracked London lower and is now 14 percent off its January peak, the ShFE lead price is hovering close to all-time highs.

The Shanghai lead squeeze that started in May is proving a lot stickier than the two previous price spikes in November 2016 and September 2017.

Its persistence suggests that a “paper market” squeeze is being reinforced by a squeeze on physical metal availability.

Graphic on Shanghai lead: price, open interest and volumes:

tmsnrt.rs/2NiUfvp

THE SQUEEZE GOES ON

The most active Shanghai lead contract last week hit a high of 20,625 yuan, close to the life-of-contract high of 20,950 yuan seen during the price spike of November 2016.

That late-2016 squeeze and last year’s repeat performance were both short-lived affairs.

Both bore all the hallmarks of the sort of high-octane bull surge that periodically rolls through China’s commodity markets. Volumes and open interest spiked as investors surfed the price momentum and both collapsed as soon as that momentum was lost.

The latest lead price surge looked to be following the same pattern until two weeks ago when both price and open interest rebounded.

Interestingly, volumes have been robust since the latest bull run started developing in early May but they have not been as spectacular as in either of the previous two spikes.

Combined with high levels of open interest, the inference is that heavier-weight investors rather than day-traders are pushing the Shanghai lead price higher.

The ShFE contract remains backwardated, nearby months trading at a premium to forward dates.

Stocks are super low.

Registered tonnage in ShFE warehouses totalled just 7,466 tonnes at the end of last week. Exchange inventory is down by 34,542 tonnes since the start of January and is the lowest it has been since January 2016.

SUPPLY STRESS

There is certainly more lead than that sitting around in China’s major ports but the mainland supply chain shows every sign of remaining stressed out.

Domestic production of lead, particularly that generated from scrap, has been roiled by repeated environmental inspections and related capacity closures.

The scrap, or secondary, part of any country’s metallic supply chain is notoriously opaque, a statistical black hole that becomes totally impenetrable in China.

Not least to the Chinese themselves, it seems, given the double-take in the Shanghai lead price two weeks ago, when the rally seemed about to fizzle out before rebounding sharply higher.

The Chinese market looks short of available units, which is one obvious reason why there is no talk of lead cuts to complement zinc cuts.

The other, even more important reason is that the continued strength in the outright price is helping to preserve lead smelting margins. That’s in stark contrast with what a falling zinc price is doing to zinc smelter margins.

Both metals are suffering from persistent raw materials tightness which has translated into low smelter fees for converting concentrates into refined metal.

Zinc treatment charges for imported concentrates are assessed by Shanghai Metal Market as being in a $20-$30 range, while lead treatment charges are a little lower at $15-$25 per tonne.

Both are painfully low for Chinese smelters. But the strength of the outright refined lead price affords some breathing space.

A QUESTION OF TIMING

Zinc and lead have both hit multi-year highs in London this year, buoyed by the same narrative of mine production shortfall.

They are called “sister metals” because they tend to be found in the same deposits with lead playing the junior role of by-product to zinc.

If there’s a shortfall of zinc concentrates, there’s going to be a similar shortfall of lead because it comes from the same mines.

In both cases the narrative has started to turn to pending supply bonanza as miners activate new production in response to those historically high prices.

But this process has played out faster in the zinc market, which has been attacked by speculative sellers in both London and China.

Expectations of surplus, however, have clashed with the reality of a still tight zinc concentrates market, generating the margin compression that led to last week’s calls for production cuts by some Chinese smelters.

Lead is not there yet.

The entire supply chain is still tight, particularly in China, which is why Shanghai prices are still close to all-time highs.

Beijing’s rolling inspection campaign of secondary producers feeds directly into the availability of refined metal.

Mined concentrates availability, meanwhile, seems to be more problematic than in zinc right now.

The International Lead and Zinc Study Group (ILZSG) calculates that global mined lead production rose by four percent in the January-April period.

The headline flatters to deceive.

Strip China’s own mine production out of the equation and that in the rest of the world slumped by 7.5 percent relative to last year.

And remember that China’s offsetting 18 percent jump in mined lead production is one of those calculations of “apparent” activity often used by the metals Study Groups to get around the paucity and unreliability of Chinese statistics.

The “apparent” jump in production could also be explained by a statistically unknowable drawdown in concentrates stocks.

The figures for what is happening outside of China are more reliable and they’re suggesting that mine supply is not only not growing but struggling even to keep up with last year’s levels.

It was always going to be difficult timing the turning point in these two metals as they transition from underlying supply famine to feast.

Bears have gone for zinc, while the bulls hold sway in lead, first and foremost in China.

Given how closely intertwined these two metals’ supply chains are, such divergence is unlikely to last for long.

But which of the “sister metals” is due the reality check?

Editing by Edmund Blair

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