Each quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – The Sucden Financial Metals Reports, April 2016.
Below is the zinc report, to download a PDF copy of the full report covering all the metals in pdf form click here.
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Zinc – On course as deficit arrives
Zinc prices, despite the arrival of a highly anticipated supply deficit, continued to sell off at the start of the year. After setting a low at $1,444.50 per tonne on January 12, prices have rallied 31.5 percent to $1,900. The combination of a previously oversold market and a growing deficit should mean zinc is now in a bull market. As the chart shows, prices are in the lower levels of the 2010-2014 trading band so there may be considerable overhead supply in the area. We expect prices to work their way through this but, with the demand profile weak, the initial strong rally – driven by short-covering – is likely to become more laboured.
Overall trend – Quite why it took zinc prices so long to respond to last year’s production cuts, in addition to the scheduled mine closures of Century and Lisheen, remains a mystery. It was probably that zinc sold off alongside other commodities, partly as a bearish bet against the slowdown in China and as deleveraging swept through the physical market while merchants, traders and consumers destocked. The fundamentals have now caught up with the forecast, shorts are covering and there seem to be signs of restocking and investment interest. We remain bullish on zinc overall because of the tighter supply fundamentals; we would become even more bullish if demand looked set to recover, which it may be doing. While the market has generally not been bullish for the economic outlook, especially for China, this may be changing. There are some signs of improved interest in the Chinese property market and the country’s auto sales have held up well, March’s manufacturing PMI was encouraging and we still expect a slow pick-up in order flow from the massive One Belt One Road (OBOR) infrastructure projects.
Market enters 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 falling to just 1,000 tonnes in January, according to International Lead and Zinc Study Group (ILZSG) data. Despite the smaller January number, it still seems highly probable that the supply deficit will grow in the months ahead – an estimated 1.25 million tonnes of output has been lost due to production cuts and closures. Our forecast is for a 220,000-tonne deficit this year but, with LME stocks standing at 420,000 tonnes and SHFE stocks at 270,000 tonnes, there is no immediate threat of any shortage, preventing prices from rallying too far. This could change, however, should the demand outlook strengthen. We are not relying on that happening in the second quarter; if it does, it will be an added bonus. China’s demand grew 1.3 percent in 2015, according to ILZSG data, and was a mere 0.4 percent higher in January. Given the size of China’s economy and official GDP growth of 6.9 percent, the low demand figure for China suggests the data is still being affected by destocking; we would not be surprised if actual demand was stronger. If higher prices prompt any shift to restocking, there could be a major impact on China’s demand data.
Bullish until supply response is made – For now the supply outlook makes for a bullish price outlook but the rise in price is likely to prompt a supply response. Producers outside China may well remain steadfast but that may not be the case in China. Chinese smelters announced cuts of 500,000 tonnes; production there in the 11 months to November averaged 515,600 tonnes per month, which on an annualised basis suggests smelters have cut output in line with their announcement. With SHFE zinc prices up 28.6 percent from the November low, it seems highly likely that Chinese zinc output will edge higher while production outside China is more likely to stay down. First, the closures of Century and Lisheen are permanent; second, prices are now only some 10 percent above where they were when the cuts were first announced. Generally, we would not expect western output to restart until stocks have retreated to more typical levels and a robust bull market is evident – one that would be able to absorb the increase in supply.
Outlook – Zinc prices have shifted from a bear market to a bull market and we expect the latter to remain in place for the foreseeable future. The price lift from oversold levels has been steep; we would not expect this to continue because short covering is likely to wane while, given the large stock overhang, we doubt consumers will feel the need to restock too aggressively. Falling stocks and the possibility of more trend-following/CTA-type fund buying may, however, continue to underpin a more gradual bull market. We expect a price range of $1,725-1,925 in the second quarter and will raise our average price for 2016 to $1,800 from $1,750.
The rise in zinc prices above $1,800 has prompted some fast and large moves in the forward spreads. They moved into large backwardations – indicative of forward selling. The 3m/5-year spread averaged $48 contango in Jan-Feb but peaked at a backwardation of $92 in March.
Zinc stocks continue to decline at a steady pace but are still high. Large deliveries have been made at times when the spread has tightened so stock seems to be held off-market. Cancelled warrants are not high, accounting for 12 percent of LME stocks.
The money managers’ gross long position has climbed in the first quarter and, while shorts continue to cover, there has been some profit-taking by longs. The continuing reduction in the gross short positions suggests they realise the fundamentals have turned more bullish now.
Physical premiums have been flat in recent months but they are edging higher on seasonal factors and on expectations that LME prices may have further to rise. We would expect mine shortages to feed through to firmer premiums in all regions eventually.
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