LONDON (Reuters) - “Zinc - Where’s the metal?”
The question was posed by analysts at ICBC Standard Bank in a research note published in February last year.
One year on and the question is more relevant than ever. London Metal Exchange (LME) zinc stocks totalled 98,000 tonnes in the middle of February 2019. They now stand at 50,550 tonnes.
This isn’t how the zinc story was supposed to play out.
Citi was proclaiming “zinc’s last hurrah” in February last year, the bank advising “producers to sell in to temporary tightness since our base case expects the market will loosen in (the second half of the year)”.
The consensus was that a surge in mine production would translate into a surplus of refined metal over 2019. A rebuild in visible inventory was a matter of time.
The outright zinc price has retreated a long way from its cycle peak close to $3,600 in early 2018, last trading at $2,370 per tonne, but there has been no sign of surplus metal making its way to LME warehouses and there has been no relief from the tightness gripping the London market.
The LME zinc market spent most of last year with tight time-spreads and the new year has started where the old left off.
The benchmark cash-to-threes period closed Wednesday valued at a backwardation of $12.50 per tonne.
That’s mild by comparison with the cash premium of $160 seen in May last year but the front part of the curve continues to be defined by spread volatility.
The LME “tom-next” spread, the shortest-dated roll period and a sensitive indicator of liquidity stress, has been trading in a slight backwardation for the last couple of weeks. What is in essence a one-day position roll cost $1 per tonne on Thursday.
The root cause of this stubborn tightness is the depleted level of stocks in LME warehouses.
There were sporadic inflows last year, particularly at the time of the acute backwardation in May. But arrivals have slowed to a crawl over recent weeks with just 3,500 tonnes entering the LME system since the start of November, all of it in Singapore.
LME stocks are the lowest they’ve been in 20 years, even lower than the trough of 60,850 tonnes seen in the last period of zinc famine in 2006-2007.
What’s in the LME system is tightly held, one entity accounting for 80-90% of available stocks and more than 90% if cash positions are included.
The dominant long may even be preventing the tightness from becoming more extreme, given rules that require the LME to lend at no more than level on at least a portion of its holdings.
So where is all the metal? How come, one year on from everyone heralding the new age of plenty in the zinc market, there’s still so little around?
Much of the answer is down to the slow transmission of surplus in the mined concentrates market to the refined metal segment of the supply chain.
Smelters’ collective capacity to convert raw material into metal was last year hampered by a string of outages, including the fire at the Mooresboro refinery in the United States, the temporary suspension of the Skorpion refinery in Namibia and lower output due to an electrical failure at the Trail plant in Canada.
Chinese smelters’ ability to lift run-rates, meanwhile, was constrained by the rolling environmental inspections that have become a feature of the country’s metallic supply chains.
Nevertheless, the global smelter bottle-neck appears to be coming to an end.
The latest figures from the International Lead and Zinc Study Group (ILZSG) show refined metal production rising by 5.7% year-on-year globally in November following a 13.2% acceleration in China.
Which suggests that if surplus metal is being generated, it is happening first and foremost in China.
There is tentative evidence the Chinese market is edging towards oversupply.
Stocks registered with the Shanghai Futures Exchange (ShFE) have risen by 21,219 tonnes since the start of January although inflows are normal ahead of the Lunar New Year holidays and the headline figure of 49,273 tonnes is still low by historical standards.
Even if there is surplus zinc in China, it is largely trapped behind the country’s export tax wall.
China’s zinc exports picked up over the course of 2019 with the cumulative outbound flow totalling 57,000 tonnes in the first 11 months.
However, what left China was more than offset by continued import strength. The country remained a net importer through the January-November period, even if the headline figure of 499,000 tonnes was 17% off the pace of 2018.
Evidently, it will to take time for surplus in China to impact the rest of the world.
The more intriguing question is whether surplus metal is also accumulating outside but away from the statistical light of exchange ownership.
It’s logical to think so and each time the LME spreads relax, the expectation is that metal is on its way to LME warranting.
Such hopes have been repeatedly dashed over the last few months, which isn’t to say that it couldn’t happen at any time, particularly given the increasing tendency of LME stocks to experience flash surges as just witnessed in the copper market.
But the nagging suspicion is that no-one is going to deliver zinc to the LME unless there is a sufficiently enticing premium.
The current mild level of backwardation is not enough. Will it take a repeat of the monster backwardations of last May to move the delivery dial?
No-one knows the answer but until the much talked-about surplus starts to lift LME stock levels, Standard Bank’s warning of ever more pronounced backwardations and resulting volatility in outright prices remains as relevant in 2020 as it was in 2019.
The opinions expressed here are those of the author, a columnist for Reuters.
Editing by Barbara Lewis