LONDON (Reuters) - Zinc has been on the climb this year, defying broader macroeconomic gloom and a previous consensus that its bull run was well and truly over.
Funds are creeping back into the market on the long side and LME broker Marex Spectron estimates speculators held a collective net long of 7 percent of open interest last Friday.
On the London Metal Exchange (LME) three-month zinc hit a seven-month high of $2,810 a tonne on Tuesday. It retraced to $2,715 on Wednesday morning but is still the second-strongest performer among the core base metals this year with a gain of 13 percent. Only nickel has fared better.
A raw materials supply crunch propelled zinc to a decade high of $3,595.50 in February last year, but as the market refocused on a wave of new mine production the price crashed back below $2,300 in August and September.
The narrative shows signs of shifting again.
While the raw materials segment of the supply chain is loosening rapidly, the flow-through to refined metal production is proving problematic.
Analysts at research house Wood Mackenzie expect another year of refined metal shortfall, with stocks declining to “exceedingly low levels” and raising the potential for a price recovery back to last year’s highs. (“Zinc: Things to look for in 2019”, Jan. 28, 2019).
Stocks of zinc registered with the LME currently total 111,775 tonnes, the lowest level since 2008.
Excluding metal earmarked for physical load-out, LME inventory is only 58,575 tonnes, as low as it has been since 2007, when zinc traded at record highs above $4,000 a tonne.
LME zinc inventory has flattered to deceive many times over the past few years, but it is noticeable that inflow has almost totally dried up this year. The only arrival in the system was a single lot of 25 tonnes at Antwerp on Jan. 25.
Moreover, almost all of the 32,775 tonnes drawn into the LME warehouse system in December by raging backwardation has since been cancelled and is now set to head out again.
Time-spreads are now more relaxed. The benchmark cash-to-three-month period closing Tuesday was at a small backwardation of $0.75 a tonne.
That implies there is more metal “out there” available for LME delivery but also means there is little cash incentive for actual delivery to take place.
The amount of zinc registered with the Shanghai Futures Exchange (ShFE) has rebuilt by 27,000 tonnes since the start of January but is still extremely low by historical standards at 46,931 tonnes.
Again, there may be more metal sitting in the off-market shadows.
One of the standouts of China’s metals trade last year was the record amount of refined zinc imported - 715,000 tonnes of it.
The cumulative draw on metal from the rest of the world has been an unprecedented 1.39 million tonnes over 2017-2018, translating into a mass relocation of available units from the rest of the world.
The strength of China’s imports signals where the raw materials supply crunch has hit hardest.
China’s production of refined zinc fell by 4.6 percent last year in what was the steepest decline in output since 2013, according to state research house Antaike.
That should change this year.
Last year’s output slide was exacerbated by Zhuzhou Smelter Group, the country’s largest producer, closing older capacity before relocating it to a new facility able to produce 300,000 tonnes a year.
More importantly, there are signs of rapidly improving raw materials availability in the form of rising treatment charges for imported concentrates.
Treatment charges, which is what a smelter charges a mine for converting concentrates into refined metal, have shot up from close to zero this time last year to $210 a tonne, according to Shanghai Metal Market.
Everyone is expecting Chinese smelters to lift production this year as conversion margins improve.
The key question is whether they can absorb the wave of new mine supply or will act as a collective bottleneck.
Zhuzhou’s smelter relocation is indicative of the environmental pressures facing China’s zinc smelters. Many were forced to curtail operations last year and several closed completely to comply with a spectrum of regulations encompassing solid, gas and waste water emissions.
Given how little spare capacity exists in the rest of the world, “the risks to the robust forecast growth in smelter production are on the downside in 2019”, Wood Mackenzie says.
Wood Mackenzie’s base-case scenario is for Chinese smelter output to rebound, but not enough to process the amount of available mine concentrate.
The research firm’s forecast is for a growing surplus of concentrates but another year of shortfall in refined metal, even assuming “very modest consumption growth”.
The International Lead and Zinc Study Group is also forecasting another year of shortfall in 2019, albeit to the tune of a relatively modest 72,000 tonnes.
But if it materialises, it will be the fourth consecutive year of supply deficit, effectively wiping out the surplus accumulated over the 2007-2012 period.
Even Wood Mackenzie warns against such robust fundamentals automatically translating into significantly higher outright zinc prices.
There is still too much macroeconomic negativity, most of it rooted in China, weighing on all the LME-traded metals.
But given the potential for continued metal deficit and the possibility of exchange stocks being “virtually eliminated” over the course of this year, zinc’s previous narrative of imminent supply surge may need a partial rewrite.
At least some investors are starting to rethink zinc.
The opinions expressed here are those of the author, a columnist for Reuters.
Editing by David Goodman