Zinc’s turn to shine?

During the early part of the summer, the high (albeit declining) stock levels left the zinc market exposed to uncertainty about global economic prospects, weakness in the galvanized steel market and the strength of the U.S. dollar. These factors combined to reduce the zinc cash quote to US$1,175 per tonne from its March 2005 high of US$1,430 per tonne. However, many of the more recent economic indicators have assuaged concerns about the rate of economic growth going forward, while the rebound in the dollar has gone temporarily into reverse.

As such, the cash quote has rallied from US$1,175 per tonne on July 7 to close to US$1,400 per tonne in early September. The rally has been supported by two “one-off” factors — the ongoing strike at Teck Cominco’s Trail, B.C., plant, which has a 290,000-tonne-per-year capacity, and the Gulf coast flooding following Hurricane Katrina, which will temporarily halt shipments from the New Orleans warehouses that account for around 50% of London Metal Exchange (LME) stocks.

The increase in zinc prices has come against a background of lower LME stocks. In August, they fell by 21,375 tonnes following a 29,650-tonne decline in July. LME stocks now stand 68,475 tonnes below where they started the year.

Hidden stocks

There has been renewed speculation concerning the existence of hidden zinc stocks with some estimates suggesting that a further 150,000 tonnes are held off-warrant. In terms of the impact on the zinc price, a number of factors need to be kept in mind.

First, the existence of hidden stocks does not preclude a sharp rally in prices. For example, zinc cash prices peaked at US$1,430 per tonne on March 16 when hidden inventories were far higher than they are today (in early June, more than 100,000 tonnes of off-warrant material was delivered into LME warehouses). The market’s reaction to the inventory surge was muted in the extreme. Accurately quantifying the remaining level of hidden inventory is nigh on impossible, given that inventory data does not exist for China, the world’s largest zinc producer and consumer. An analysis of the difference between the market balance and changes in reported inventory since the beginning of the decade suggests that the current hidden stock level (post the 100,000 tonne jump in LME stocks) is below rather than above 100,000 tonnes. In terms of our revised price forecasts for 2005-06, we don’t believe that the existence of hidden stock levels will have a negative impact on prices.

Cuts impact zinc demand

The latest International Lead Zinc Study Group (ILZSG) data highlights the consumption weakness that has begun to emerge. Its initial estimates for the second quarter show a 4.3% year-on-year decline to 1.831 million tonnes. The decline is from an inflated 2004 base of 1.913 million tonnes. Given the cuts in place at galvanizing mills, we expect that the ILZSG data for the third quarter will show a similar lacklustre demand environment.

However there are already some signs that the corrective action taken by the galvanizers is beginning to have an impact on prices that might allow higher output (and stronger zinc demand) in the fourth quarter.

— The preceding is an edited version of a recent information bulletin published by London-based GFMS Metals Consulting.