Macquarie : Zinc to take a breather

London , 31 Oct 2016

This article is an opinion piece written by Macquarie Securities senior base metals analyst Vivienne Lloyd. It was first published in Mining Journal.

Zinc has been the most impressive rebounding commodity in 2016, with prices climbing more than 40% year to date to circa-US$2,250 per tonne, having been as low as $1,445 per tonne back in January. With the rally losing steam more recently, however, and failing once again to break $2,400 per tonne, some ask whether the price performance has been a case of too much, too soon.

Zinc is used in galvanising steel, in brass and diecast alloys, and in the form of zinc oxide to vulcanise rubber tyres. End-use is therefore geared towards infrastructure and non-residential construction (44%) and transport including automotive (24%), with the remainder shared between consumer goods (16%), residential construction (9%) and industrial machinery (7%). Demand for the metal has been the beneficiary in 2016 of strong Chinese infrastructure investment and automotive production globally. In the case of the former, growth has been stimulated by the Chinese government's vast credit injections designed to rally its slowing economy in the early part of the year.

With the private sector still wary of the domestic economic climate, the credit loosening has ended up flowing towards public sector development, meaning a boost to construction and infrastructure. On the transport side, automotive manufacturing has been strong globally, with Chinese vehicle output up 13% in the first nine months of the year, according to the China Association of Automobile Manufacturers. European sales were up 7.7% over the same period. These strong results have offset weakness in galvanising in other regions, particularly South America and Russia, to ensure zinc demand has seen positive growth so far in 2016. We expect 1.7% growth for the full year, rising to 2.4% next year as the negative impact of Brazilian galvanizing demand contraction fades.

This stable consumption growth allowed prices to stop falling earlier in the year. The strong rally that followed, however, has much more to do with supply, or the lack thereof. At the turn of the year, two large mines - MMG's Century in Australia and Vedanta's Lisheen in Ireland - finally ended operations due to economic resource exhaustion. This had been anticipated for some time, and smelter customers had plans in place to cope with their departure.

What had not been anticipated, however, was number one zinc miner Glencore's shock decision, a year ago, to halt half a million tonnes worth of zinc-in-concentrate output at its mines around the world. The miner/trader cited low prices, and declared their resolution to 'leave [the reserves] in the ground'. Of course, the ultimate intention was to drain global concentrate stockpiles and force smelter cutbacks that would result in substantial refined metal deficits - leading to falling inventories and higher prices.

Initially an air of scepticism pervaded, and zinc prices ended the year even lower as wider commodity pressure swept zinc down with the rest of the London Metal Exchange complex. The turning point came in February, when Glencore's December quarter results were published showing a steep decline in zinc output on top of announcements by both MMG and Vedanta that the final shipments from their mines had been despatched. Spot zinc concentrate treatment charges (TCs), which are the discount that smelters apply to the zinc exchange price to cover the cost of processing, were already plummeting (indicating a sellers' market) and the benchmark TC for 2016 long-term supply contracts between miners and smelters was set 17% lower than the prior year. Smelters were feeling the squeeze.

Through 2016, TCs continued to fall, as did imports of concentrate into China. China produces just under half of the world's refined zinc, but its smelting industry is heavily populated by small, inefficient plants. The average capacity of the smelters we track is around 70,000 tonnes per annum in China, compared to typical sizes of at least 150,000tpa outside China. With too many smelters and not enough feed, sellers are prioritising larger customers and their strongest relationships, leaving many Chinese smelters out in the cold. Concentrate stocks in the country are said to have fallen to just a couple of weeks, meaning we are on the verge of cutbacks.

Throughout all this, while mine output is expected to fall by 5.4% in 2016, the refined market has shown no sign of scarcity, and ingot stock levels are said to be comfortable. We feel this clashes with the strong price levels attained thus far, and that a shallow retracement is likely into the December quarter while we await the smelter cuts.

Next year, however, looks to be the year the metal tightness will kick in. Concentrates stocks will be at rock-bottom levels, and ingot deficits of 275,000-475,000tpa will hit the market, dragging down inventory levels. Throughout this period, we expect prices to rise in order to stimulate greater supply, destroy demand, or more likely both.

We anticipate strong mine supply growth from China, which produces some 42% of global output, and we will see Vedanta ramping its Gamsberg project in South Africa from 2018. On the other side, demand is likely to be affected by higher prices, with diecast alloys the product we think most likely to suffer substitution with aluminium or plastics.

These forces will eventually bring the market back into balance by the end of the decade, but in the meantime we expect to see zinc prices rallying to a peak in 2019, averaging over $2,800 per tonne.

For more information on the report 'Commodities Comment - Zinc: Mirror, mirror, on the wall...' (29 September 2016) contact Macquarie Research.