By Andy Home
LONDON Feb 19 (Reuters) - Not so long ago, zinc and lead were the "ugly sisters" of the London Metal Exchange (LME) base metals suite, both burdened by consecutive years of surplus and high inventories.
The peak of the commodities super-cycle has come and gone, and you'd be hard pressed to discern its passage through the prism of these two industrial metals. With no spectacular bull runs such as seen in copper and iron ore, they went through a long, long period of largely sideways grind.
Sentiment is now changing, particularly for zinc, which is currently the "belle of the ball" on the LME. Three-month zinc was the best relative performer last year, an act it is repeating in the early part of 2014.
This turnaround in fortunes appears to be borne out by the latest figures from the International Lead and Zinc Study Group (ILZSG), assessing both markets as shifting to production-usage deficits in 2013.
It was the first year of lead deficit since 2009 and the first year of zinc deficit since 2006.
The previous sentence should probably include the word "probably".
Right now, the LME "Street" is expressing its bullish views by playing the two sister metals off against each other, a relative play that currently favours zinc.
Left to one side, however, is the nagging question of where all those legacy stocks have gone. It is possible that there is still an ugly side to both Cinderellas?
DEFICIT ... PROBABLY
ILZSG calculates that the refined zinc and lead markets recorded a production-usage shortfall of 60,000 tonnes and 20,000 tonnes, respectively, in 2013.
These, it is worth stressing, are marginal outcomes in what are 13 million and 10.5 million tonne global markets.
Moreover, not everyone is in agreement.
"Disconcertingly, our sources still differ greatly on the recent market balance," observes Stephen Briggs, an analyst at BNP Paribas, in a recent research note on zinc ("Zinc transitioning from rattle to hum," Feb. 12, 2014).
"Wood Mackenzie has world refined demand exceeding production by over 650,000 tonnes in 2012-13, whereas CRU has a balance in 2012 and a surplus in 2013, with ILZSG data the other way round," he explains.
These are the three pillars of fundamental insight into the zinc market, so the divergence in views is genuinely disconcerting.
Briggs, by the way, takes what he calls "a middle path", expecting "modest headline deficits to morph into something more structural by 2016".
The zinc market is a relative beacon of light in comparison with lead, which has a higher scrap component, in the form of lead-acid batteries, than any other metal market.
Scrap is a notoriously opaque part of the supply chain, and shifts in the scrap dynamic have frequently caught the refined lead market collectively off-guard in past years.
If ILZSG's calculation of zinc deficit is open to interpretation, as it apparently is, then even more so is any assessment of marginal deficit in the lead market.
Still at least we can all agree, probably, that both markets are somewhere along the path from chronic oversupply to supply shortfall.
They are on the same journey for the same reason, namely the depletion of some of the world's largest zinc mines, a lack of replacement supply and problems with the few new mines that are coming on stream.
China's MMG is the prime example of this phenomenon. Technical problems have led it to defer its Dugald River mine, which was intended to be a partial offset against the closure of the giant Century mine next year.
But it's not the only player facing such issues.
This week problems have arisen at another important new mine, Perkoa in Burkino Faso. Glencore-Xstrata, which owns 62.7 percent of Perkoa and needs it to help compensate for zinc mine closures in Canada, has challenged minority shareholder and operator Blackthorn Resources over the mine's economics.
Blackthorn has already ceased open-pit operations at Perkoa and is now considering a number of "schedule, cost and capital scenarios". One scenario is to place the whole mine on care and maintenance until the zinc price improves further.
Since the sister metals are normally found in the ground together, every zinc mine that closes takes out a bit of lead supply as well.
It's just a case of which market will be first to see mine supply constraints translate into a metal shortage.
The current LME relative-play betting is on zinc. The lead-zinc premium has shrunk to around $100 per tonne, the narrowest it's been since the third quarter of 2012.
Global zinc mine supply growth braked sharply from over 3 percent in 2012 to just 1 percent in 2013. Indeed, mine production outside of China contracted marginally last year, according to ILZSG.
Lead mine supply growth also slowed last year but much more moderately to a still robust 6.4 percent globally.
Zinc's bullish credentials are further enhanced by a more exciting usage profile. ILZSG calculates that global usage grew by 7.4 percent last year, outpacing a 4.5 percent rate in the lead market.
WHERE HAVE ALL THE STOCKS GONE?
Which is maybe why visible zinc stocks are falling harder and faster than those of lead right now.
LME-registered zinc inventory fell by 290,000 tonnes, or 24 percent, last year, and at 795,000 tonnes is already down by another 15 percent so far this year.
LME lead stocks shrunk by 104,000 tonnes, or 33 percent, last year and have also continued sliding this year, down another 6 percent at 201,875 tonnes.
These downtrends have served to fuel the bull chorus surrounding both metals' prospects.
But are they true signals? And just where exactly has all this metal gone?
Neither stocks drawdown fits well with the ILZSG's assessment of underlying production-usage balance, as shown in the next two graphics:
LME stock falls last year far exceeded calculated deficits in both markets.
Indeed, LME lead stock movements have been seriously out of kilter for the past two years, although the ILZSG figures do suggest some redistribution to producer stocks.
There is no such suggestion when it comes to the 290,000 tonnes of disappearing zinc. Indeed, total stocks including ILZSG assessments of industry inventory fell even harder, to the tune of 314,000 tonnes last year.
Maybe this is just a sign that the ILZSG is under-estimating the scale of deficit in each market.
Or, maybe, these dramatic movements have had more to do with the formation of load-out queues by LME warehouse operators.
Exchange stocks of both metals have tended to be concentrated in what the LME calls its "affected" locations, particularly New Orleans and Antwerp in the case of zinc and Vlissingen and Johor in the case of lead.
Surplus zinc and lead flooded into these locations only to be swiftly cancelled, blocking the departure of other metals. It has since been leaving daily, the pace of drawdown conforming with LME rules on minimum (de facto maximum) load-out rates at queue-affected locations.
This is a headache for the LME, because stocks flows have lost much of their analytical relevance due to such gaming of the warehousing system.
But it is also a headache for zinc and lead bulls, leaving a nagging doubt that surplus metal has merely flowed through the LME system and is now, once again, gathering dust in off-market storage waiting to be dumped back into statistical visibility at a more attractive price.
Not such a pretty scenario for the two new "belles of the ball".