Each quarter FastMarkets and Sucden Financial produce an analysis and forecast report on the precious and base metals – The Sucden Financial Metals Reports, Jan 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 Prices out of sync with supply outlook
The rallies in early 2014 and 2015 were pre-emptive, anticipating the shift to a supply deficit that is finally expected to come about. It is ironic that the supply deficit is finally likely to emerge now that prices are 38 percent lower than those peaks. Sentiment across the base metals is washed out while China’s economic outlook continues to disappoint. With output cuts and mine closures in progress, the supply side looks set to tighten considerably; once the downside outlook becomes limited, short-covering alone is likely to be enough to lift prices considerably. We are more bullish than bearish at these levels.
Overall trend – The sell-off in zinc prices since last May’s peak of around $2,400 per tonne has been relentless, especially given that zinc’s supply fundamentals were set to tighten for structural reasons that were well telegraphed, and while additional production cuts will add to the supply response. There are reports that the Chinese, who have been prevented from shorting equities, have shorted the metals markets as a means to get short exposure against a deteriorating Chinese economy. This would help explain why zinc prices have seen such a meltdown, which has been hard to explain given the fundamental outlook. Another factor that might have prompted the weakness is if physical trading houses have unwound their metal financing to cut borrowing costs. Such an action could have led to a significant swing in metal returning to the market from off-market. LME stocks have also been falling, a move unsurprisingly centred on New Orleans – that is where 80 percent of LME stocks are and where 88 percent of cancelled warrants are. The question is: how much of the stock fall represents metal moving out of LME warehouses into off-market financing deals and how much is moving out to consumers?
Supply deficit expected – The zinc market was in a supply surplus of 213,000 tonnes in the first 10 months of 2014, up from 150,000 tonnes in the first seven months of the year, according to the International Lead and Zinc Study Group (ILZSG). But the latest data showed a 15,000-tonne deficit in October and, with production cuts announced that month and with mine closures unfolding in the final months of the year, we expect deficits to become the norm; indeed, weaker treatment charges suggest smelters have been restocking in anticipation of a tighter market. Once the official data highlights this, we expect the market to sit up and take note. In the past when ILZSG data has highlighted switches from surplus to deficit, the market has reacted; given how short the zinc market is believed to be in Shanghai, we would not be surprised if this happens again. Since falling zinc prices are likely to have led to destocking throughout the industry, a switch to a deficit is likely to prompt some restocking, which in turn would provide a boost even if actual demand stays flat.
All eyes on China – China remains the most important factor in zinc consumption – the country accounts for around 47 percent of global consumption. Chinese zinc consumption is skewed towards the construction and infrastructure sectors, which account for some 60 percent of demand, while transport and white goods account for the rest. The use of galvanised steel in the auto industry in China is a growth market – traditionally, auto steel has been paint-coated rather than zinc-coated; as this changes, it should be a positive factor for zinc. Any sign of improvement in China’s economic outlook could quickly change sentiment from being outright bearish to bullish. We would watch for any sign of a pick-up in order flow from the massive One Belt One Road (OBOR) infrastructure projects. If these unfold, China’s economy – and especially the metals industries – could get a much-needed boost. This could singlehandedly turn sentiment round.
Outlook – Zinc prices remain oversold, which we attribute to a combination of distress selling by traders and short selling by Chinese funds. The relentless price weakness has now led market watchers to question whether the tighter supply fundamental outlook will emerge. We think it will – the production cuts that have been announced could ultimately mean a significantly larger deficit that previously envisaged. Indeed, Glencore cutting 500,000 tonnes of production when its mines may not have actually been loss-making is an unusually proactive stance by the producer; other actions such as these may well create a big enough deficit to rid the market of the stock overhang that has built up over recent years. We expect a price range of $1,450/1520-1,700 in the first quarter and an average price for 2016 of $1,750.
There is some tightness in the c-3s but it is still in contango. Still, the pick-up in the forward contangos suggests there is forward buying interest that is taking advantage of the low benchmark three-month price.
Despite bouts of strong stock inflows, the overall trend remains to the downside – despite a relatively low level of cancelled warrants. LME stocks at 455,200 tonnes are now 63 percent down from the 2012 peak.
The money managers’ gross long position has flattened out at a low level while the short position is shrinking. SHFE open interest and price data suggest some large short fund positions – this is where we see risk.
Physical premiums are yet to show any tightness in the market – premiums are generally flat although there has been some pick-up in Asian premiums. We would expect mine shortages to eventually feed through to firmer premiums in all regions.