LONDON (Reuters) - The London Metal Exchange (LME) base metals markets were a scene of carnage on Wednesday.
The LME Index (.LMEX), a basket of the exchange’s six core contracts, slumped by almost four percent in a single day.
The bloodbath is part and parcel of the turmoil playing out across the financial market spectrum.
But industrial metals find themselves at the epicenter of investors’ fears about global, particularly Chinese, growth and escalating trade tensions. A rising dollar and a falling yuan simply reinforce the macro negativity.
If Doctor Copper and his metallic friends are to be believed, global manufacturing is heading for a cliff-edge.
But should we believe them?
Those analysts that track the complex are not convinced.
“There were no metals-specific data or news that could explain the price slump,” according to Commerzbank’s daily commentary.
“We regard the price slide as exaggerated, absurd and unjustified.”
Is the price rout signal, or noise?
Although copper inevitably grabs the headlines at times such as these, a more interesting perspective on the question is offered by zinc.
Graphic on LME Index and daily change: reut.rs/2nHlgNp
Graphic on LME zinc chart patterns: reut.rs/2BeITq1
LME three-month zinc hit an 11-year high of $3,595.50 per tonne in February.
On Wednesday it touched a near two-year low of $2,283 per tonne, representing a 33 percent decline over the space of just six months.
Even by the volatile standards of industrial metals, it has been a brutal fall from grace, with a deteriorating narrative and technical picture creating a negative feedback loop.
The reason zinc got as high as it did earlier this year was because everyone was worried about a supply crunch.
Just as soon as it hit those 11-year peaks, however, the narrative focus switched to all the new mine supply coming in reaction to higher prices.
Events since then have seen that bearish supply narrative encompass the demand side of the equation.
Zinc’s use in galvanised steel leaves it exposed to any slowdown in China’s construction sector, a prospect which was worrying metals traders even before the U.S. fired the first salvoes in the trade war.
Tariffs on U.S. steel imports compounded those fears. Tariffs on Chinese goods have thrown yet another ingredient into the bearish mix.
A darkening outlook for zinc’s fundamental prospects has been accompanied by a steadily deteriorating technical picture.
A key chart support area around the $3,000 per tonne level was breached in June. Another big one at $2,475 was taken out on Wednesday with a noticeable surge in trading volumes as it fell to the bear onslaught.
Throw in a possible one-year head-and-shoulders chart pattern, something of a holy grail for chart-followers, and it is no surprise that technical and systematic funds have been chasing zinc lower.
LME broker Marex Spectron estimates speculators were net short of zinc to the tune of 18 percent of open interest at the start of this week, a level that will only have increased in the latest leg lower.
The only deterrent to short-sellers was tightness in the LME time-spreads, but they too have now collapsed. This time last week the benchmark cash-to-three-months period was valued at $160 backwardation. As of Wednesday’s close it had flipped to a $16.50 contango.
For zinc bears, it has been a perfect ride. For bulls, it has been the perfect storm.
Seen on its own specific terms, however, zinc is not offering much evidence to support a 33 percent price decline.
Quite the opposite in fact.
Chinese refined zinc production in July was down 3.5 percent year-on-year and at 439,000 tonnes the lowest national run rate since August 2013.
The monthly figures from the National Bureau of Statistics come with a heavy statistical health warning, but the trend of falling year-on-year production has been running uninterrupted for many months now.
It tallies with most analysts’ assessments and with what Chinese smelters have themselves been saying.
They announced a coordinated cutback programme at the end of June. As ever with such announcements in China, there was little in the way of detail, and it was probably no more than a way of window-dressing cuts that were already taking place in the form of scheduled smelter downtime.
The significance of the announcement was more in what it revealed about the level of producer pain in the Chinese smelter sector.
Margins have been crushed between a falling zinc price and low treatment fees, the latter still reflective of a shortage of raw material.
Had this happened during zinc’s bull rally over 2016-2017, it would have been seized on as proof of a raw materials crunch.
Right now, a potentially bullish signal emanating from the physical zinc market is simply drowned out in the noise of macro-induced fund selling.
Any hard evidence of actual demand slowdown, meanwhile, remains elusive.
The entire global steel sector is still in a sweet spot, with production and margins rising in just about every major producer, first and foremost China itself.
The galvanised part of the sector can and often does gyrate to its own stocks cycle but its broader fortunes remain linked to the bigger steel picture, which remains surprisingly robust.
Zinc “prices have fallen ahead of fundamentals” was the view of research house CRU, cited by Fitch Ratings in an Aug. 7 outlook on the global mining sector.
Well, they have just fallen quite a bit more ahead of fundamentals. Such is the way of commodity markets, particularly when technicals and narrative reinforce each other.
However, if there is a lot of “noise” to the current zinc sell-off, it may yet generate a signal, albeit not the one expected.
Zinc’s implosion since February started with a change of collective view about mine supply, namely an anticipated switch from famine to feast.
But the prospect of feast was predicated on a super-strong zinc price above $3,000 per tonne incentivising both new mines and the reactivation of old, dormant facilities.
The chances of all those projects now entering production are much diminished at current price levels.
Maybe the world is not going to need them if the worst fears about trade tensions materialise.
However, if zinc’s price collapse is irrational pessimism, the market has a problem, and it’s not going to be one of oversupply.
The opinions expressed here are those of the author, a columnist for Reuters.
Editing by Jan Harvey