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COLUMN - Investors lose faith in zinc's slow-burn story: Andy Home
Tue Mar 17, 2015 8:46am EDT

http://www.reuters.com/article/2015/03/17/zinc-market-ahome-idUSL6N0WJ2PB20150317

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Andy Home

(Reuters) - Whatever happened to zinc?

It was one of last year's hot metal markets with investment players rushing to buy into a compelling story of imminent supply crunch.

The London Metal Exchange (LME) price for three-month delivery has, however, been falling steadily since the heady days of last September when it was trading above $2,400 per tonne.

It's now retreated all the way back to the $2,000 level, which is where it was this time last year before everyone got so excited.

Of course zinc has been buffeted by the same headwinds as the other LME-traded base metals, namely dollar strength and uncertainty about the state of play in China, the biggest market for all things metallic.

But zinc's fall from grace has also been specific, reflecting a growing sense of frustration with a narrative that promised so much but has delivered so little.

Supply crunch is still looming, just as it has been for several years now, but it's palpably not here yet.

RETREAT

Zinc's slow-motion collapse has been accompanied by an unwinding of money manager long positioning on the LME contract.

The LME's new Commitments of Traders (COTR) report is by no means a perfect lens through which to see investment flows on the exchange but the managed money category gives some idea of what's happening with speculative positioning.

Back in July 2014, when the COTR was first published and when zinc was storming up to what would turn out to be three-year highs, money managers' net long positioning LME-ZS-MNET amounted to almost 100,000 lots (2.5 million tonnes) and represented 22 percent of open interest.

As of March 6, that collective net long had dwindled to 38,622 lots and just 9 percent of open interest.

Money managers have both trimmed long positions and increased short positions, the latter amounting to 72,622 lots as of March 6, the highest level since the COTR was launched.

The LME's money manager category captures many of the technical funds operating in the metals markets and to some extent their collective retreat does no more than mirror the steady deterioration in zinc's chart picture over the last few months.

ELUSIVE DEFICIT

The real problem for zinc bulls has been a similar deterioration in the fundamental picture.

Sure, LME zinc stocks continue to fall. Indeed, they are falling faster than those of any of the other LME-traded metals, down by 157,175 tonnes so far this year.

Moreover, the amount of metal sitting in the cancelled category awaiting physical drawdown is high at 143,600 tonnes, equivalent to 27 percent of total inventory.

But do these stock trends signal supply deficit or the sort of storage arbitrage between on- and off-exchange warehouses that has come to characterise the aluminium market?

When 91,400 tonnes of metal are cancelled in a single day at a single location, as happened to zinc in New Orleans on Feb. 10, the volumes suggest a mass relocation, not a tapping of exchange stocks by users struggling to locate sufficient physical units.

Indeed, the refined zinc market shows every sign of being comfortably balanced right now.

The most recent assessment from the International Lead and Zinc Study Group (ILZSG) was that the refined market was in a small surplus in both December and January.

It's a far cry from last year, when the Group's monthly calculated deficit headlines provided the bullish beat to which money flooded into the market.

THE CHINA PROBLEM

The ILZSG data do still point to an underlying deficit in this market and the mine closures, which lie at the heart of zinc's bull narrative, will come.

The giant Century mine in Australia has epitomised the slow-burn nature of this narrative, operator MMG seemingly always finding just a bit more ore to eke out operations.

This year, though, Century will definitely close with MMG slashing zinc guidance as a result.

The analysts' consensus is still that supply shortfall will come and when it does, it will generate higher prices, although you'd be forgiven for experiencing a strong sense of deja vu since that was precisely the consensus that sent zinc on its bull run last year.

The really big problem for zinc bulls, though, is China and its potential to lift production, both mined and refined, in response to higher prices.

Which is a really big problem for everyone, since assessing China's capacity to do so means dealing with some of the least reliable statistics in the global zinc market.

But the trends at least are fairly clear.

According to ILZSG, global mine production rose by an anaemic 1.8 percent last year - but that headline figure masks two very different outcomes.

In the world outside China, production fell by 0.7 percent, which is what might be expected given the supply hits resulting from closures of worked-out mines such as Brunswick in Canada.

Production in China, by contrast, increased by 6.5 percent last year.

The same pattern is evident at the refined metal stage of the supply chain. In the world outside China output fell by one percent but in China itself production rose by 14 percent.

And that trend seems to have become more pronounced this year, with official figures showing an 18 percent jump in China's production of refined zinc over the first two months of this year.

Take the figures with a large pinch of salt but the trend is more difficult to argue against. The inference is that China has no shortage of smelting capacity nor of raw materials to feed that capacity.

GOOD THINGS COME TO THOSE THAT WAIT?

Nor is China taking much metal from the rest of the world. Net imports collapsed over the back end of last year.

As imports have fallen, reflecting higher domestic production, exports have surged, as collateralised metal flows to safer-haven storage outside China in the wake of last summer's Qingdao port multiple-pledging scandal.

The country has been a marginal net exporter over the last four reported months, reversing what was previously a one-way inbound flow.

It's just another bit of bad news for those bulls still hanging on in there in the zinc market.

Their time may well come. But that day still looks a long way away.

In the interim, it seems, many have simply lost patience and are now voting with their feet and their wallets.