LONDON (Reuters) - Is that it for the zinc rally?
After hitting a 10-year high of $3,595.50 per tonne in February, the London Metal Exchange (LME) price has been sliding ever since.
The retreat has extended to $2,946.50 so far on Thursday morning, the lowest level since August last year.
Expectations for one last bull hurrah have faded as exchange stocks have rebuilt, apparently calling time on the supply chain tightness that underpinned zinc’s two-year charge from the January 2016 low of $1,444.50 per tonne.
As ever with this particular metal, though, appearances can be deceptive, as shorts have just found out to their cost.
Time-spreads across the front part of the LME zinc curve have tightened sharply over the last couple of weeks, a seemingly anomalous outcome given rising inventory.
LME zinc stocks, however, remain as unreliable an indicator of actual market dynamics as they ever were.
They fooled bulls on the way up and they’re now fooling bears on the way down.
(Graphic on LME zinc spreads: tmsnrt.rs/2MbeHwG)
The LME’s benchmark nearby spread, covering the cash-to-three-months period, closed Wednesday valued at a backwardation of $42 per tonne.
The tightness is not as extreme as it was at one point in October last year, when the same spread flexed out to a cash premium of $91 per tonne.
But just a month ago the front part of the forward curve was trading in comfortable contango in excess of $20 per tonne.
The spreads tension is widely dispersed with cash-to-July this morning trading at $37 backwardation, July-August at $15 backwardation and August-September at $3 backwardation.
“Tom-next”, the shortest-dated spread of them all and a good indicator of positioning stress around the cash date, traded out to a backwardation of $12 per tonne on Thursday morning.
What’s curious about the current tightness is the absence of any obvious perpetrator.
No dominant holder of LME stocks has been gracing the exchange’s daily warrant position reports.
A couple of larger cash positions have featured sporadically, one of them stepping up into the 50-80 band of available tonnage as of today’s report.
But this is all unremarkable stuff, leaving the impression that shorts have simply got over-confident about the speed of the market’s rebalancing from supply shortfall to supply surplus.
(Graphic on LME zinc stocks at New Orleans: tmsnrt.rs/2JWSTID)
LME STOCKS - SEEING IS BELIEVING?
That over-confidence is in part down to what has been happening to LME stocks.
At a headline level LME-registered stocks hit their lowest point of this cycle, 131,775 tonnes, at the start of March. Five years ago there were over 1.2 million tonnes of zinc in the exchange’s warehouse system.
What was actually available to the market on March 1, excluding metal awaiting physical load-out, was just 83,700 tonnes. Not entirely surprisingly, such thin stocks cover coincided with the last bout of spreads tightness.
Fast forward three months, however, and there are now 247,450 tonnes of zinc in the LME warehouse system.
Just about all of it is “live” tonnage because the amount of metal now awaiting load-out is 8,225 tonnes, representing a marginal 3.3 percent of the total.
Higher stocks plus lower cancelled tonnage should, on paper at least, mean low demand for LME metal and, by inference, a well-supplied physical market.
The stocks rebuild, however, has been far from system-wide but rather limited to just two locations.
A total of 60,050 tonnes were placed on LME warrant at the Belgian port of Antwerp over three days in late April. Not a tonne of it has since been touched.
The only other active location has been New Orleans, which saw 78,950 tonnes “arrive” on a single day, March 2, and which has seen sporadic inflows since the end of May, most recently Wednesday’s 1,525 tonnes.
This, however, is very unlikely to be newly-produced surplus metal finding its way onto the LME but rather the old New Orleans stocks carousel still turning, albeit a little more slowly than in the past.
New Orleans has been the dumping ground for unwanted zinc for decades, thanks to its relative isolation from any consumption hot spot and the resulting lack of impact on physical premiums in other regions.
At times the zinc becomes visible when it enters the LME reporting system. Most of the time it lies in the statistical shadows of off-market storage.
The rotation between LME and cheaper non-LME storage in the port has seen 1.6 million tonnes “arrive” and 2.2 million tonnes “depart” LME sheds over the last five years.
Most of that movement has been no more than statistical noise, offering minimal read-through to physical market dynamics.
Moreover, some of it has been riding the New Orleans roundabout for years and there has been persistent market chatter that the more recent “arrivals” have been of metal rejected by buyers on age and quality grounds.
It’s a truism that the LME is the market of last resort for physical buyers, but when it comes to the zinc in New Orleans, it may well be the market of truly last, last resort.
That may be the reason there is so little LME cancelled stock awaiting load-out.
It’s not that there’s so much other metal available “out there”, it’s just that whatever is “out there” is newer and more desirable for physical buyers.
It’s curious that zinc shorts have drawn any comfort from this veneer of availability represented by LME stocks.
After all, there were several false starts to the rally as bullish expectations were dashed by heavy-volume “arrivals” of zinc in the LME system, all of them at New Orleans.
Just as New Orleans was a poor signal for timing the bull rally, it may be as equally unreliable an indicator for bears.
In terms of underlying supply-chain dynamics, it’s not what you see at New Orleans that counts, but what you don’t see.
Analysts at Wood Mackenzie wrote in January they estimated global refined zinc stocks had fallen by 900,000 tonnes to 1.8 million tonnes over the course of 2017. Only 250,000 tonnes of that change, however, was visible from movements of exchange stocks.
It’s impossible to say how much “invisible” stock is still out there, although there is certainly less on the New Orleans carousel than there was a year ago.
Commodity markets don’t switch from supply deficit to supply surplus overnight. The supply pressures that took years to propel the zinc price higher are still working themselves out.
The market will rebalance and the price will fall at some stage but the last place to look for evidence of that transition is probably New Orleans.
Zinc bears believed otherwise, which is why they’re struggling to roll out of a spreads trap.
The opinions expressed here are those of the author, a columnist for Reuters.
Editing by David Evans