Each quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – the latest are Sucden Financial Metals Reports for July 2016.
Below is the zinc report. To download a PDF copy of the full report, please click here.
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Zinc – Outlook bullish, prices may be ahead of themselves
Zinc prices have continued to work higher during the second quarter, extending gains to $2,170 per tonne from a high of $1,877.50 in the first quarter. The fundamentals remain bullish – production cuts remain in force and in recent months data has been showing a supply deficit. The physical market is quiet, however, and higher prices have attracted some deliveries into LME-registered warehouses so the funds are believed to be driving much of the bullishness. There is potential for profit-taking, producer hedging and reactivations of idle capacity that may cause corrections or at least may slow the rally down. Whilst there is technical potential for the price to reach $ 2300 this would probably attract profit-taking, producer hedging and reactivations of idle capacity that may cause corrections or at least may slow the rally down.
Overall trend – Zinc is in a pronounced bull market. Prices turned the corner in January from a low of $1,444.50 and have since trended higher, with routine and limited corrections along the way. So far prices have reached $2,190, a rise of $725 or 51 percent from the low – the largest correction was in May when prices dropped $149. The physical market has not yet tightened, with good availability generally reported and the market only really swinging into a deficit in March but with high levels of stocks providing more than enough cover. While it looks as if higher prices have been driven by a combination of short-covering and fresh buying by funds, shorts have more recently started to short again. Since the deficit is expected to get larger, an overall upward trend is expected but, given considerable economic uncertainty, the large fund long position could lead to some profit-taking sell-offs. As well, higher prices could prompt producers to start up idle capacity.
Market swings in and out of supply deficit – The zinc market moved into a supply deficit in October last year; monthly deficits averaged 31,600 tonnes in the fourth quarter before returning to supply surpluses in January and February and then back to deficits in March and April, according to International Lead and Zinc Study Group (ILZSG) data. The overall swing towards a deficit seems to be all that the funds required to get bullish. The bulls have been waiting for the switch to deficit from early 2014; there was a strong rally in March-July 2014 and again in March-May 2015 but third time lucky – this year’s rally has had legs. There is a danger that prices are running ahead of themselves – the current market may be showing a deficit but there is no shortage of metal as the physical market shows and off-market stocks may be as high as 3 million tonnes. As in aluminium, the metal is being profitably held off market so it may not get in the way of the rally for now but those holding the stocks may well be tempted to reduce their holdings on a scale-up basis, which could start to cap the upside.
Money managers getting more polarised – The money managers’ net position on the LME has moved from being net short at 2,542 lots early in November to net long at 69,271 lots. Initially, the increase in the net long position climbed because of short-covering, which remained a driving force until early May. Fresh buying did not start until mid-February but it started to accelerate late in May when dip-buying was triggered. The correction also prompted short-selling. As of early July, the longs are getting longer and the shorts are getting shorter. In the absence of a pick-up in physical buying, there is a danger that some longs start to take profits. The net long money managers’ position is 69,271 lots; its previous peak was 99,251 lots in mid-May last year. So while there may be room for the longs to increase their holdings further, the lack of physical buying and a pick-up in short-selling means a sell-off triggered by profit-taking could be quite aggressive.
Outlook – There is little doubt that zinc is in a strong bull market and the market fundamentals (putting off-market zinc stockpiles to the side) are supportive. Demand is not particularly strong – as with all the metals, it is waiting for a stronger recovery in China – but while supply is restrained, a supply/demand deficit is likely to underpin prices. The dangers over the third quarter are likely to come from fallout from the Brexit or from a development that prompts profit-taking, which could be as simple as a stronger dollar. Overall, we expect a more gradual bull market, but for there to be profit-taking sell-offs along the way. We expect a price range of $1,940-2,300 in the third quarter. Our forecast for 2016 was for prices to average $1,800; in the first half the average has been $1,799. We would look to raise the average for 2016 to $1,900.
The far-forward spreads have been bid out into bigger backwardations due to producer forward selling. In the second quarter, the 3m/5-year spread averaged $75 back from $14 contango in the first. It peaked at $113 in June but has not been bid out again despite stronger prices.
Zinc stocks have seen some inflow recently but the overall trend is downward. What is notable is the drop in cancelled warrants to 15,000 tonnes, accounting for three percent of total stocks. This means there should be good availability in LME zinc – the fund shorts may like that.
The money managers are getting more polarised while longs buy and shorts continue to short. The net long money managers’ position is relatively large but longs and shorts could still both expand. A showdown, either profit-taking or short-covering, could follow soon.
Physical premiums picked up in March/April but have since edged lower again, which highlights the quiet conditions in the zinc market. Price activity therefore looks somewhat out of step with actual demand, which highlights the strong fund activity.