COLUMN-Who's not afraid of being short zinc?: Andy Home

Wed Mar 5, 2014 9:16am EST

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

By Andy Home

LONDON, March 5 (Reuters) - Zinc is on a bull charge.

On the London Metal Exchange (LME), three-month metal took out resistance at $2,100 per tonne on Tuesday and has since powered to a one-year high of $2,143.50.

The "Street" is in thrall to zinc's bull narrative, a stand-out in an otherwise featureless base metals landscape.

That narrative has just been given the thumbs-up by one of the market's most powerful players.

"The much anticipated tightening of zinc mine supply is starting to materialise," was the headline on one of the slides accompanying Glencore Xstrata's results.

The subsequent bullet points spell out the reasons for zinc bulls to be cheerful:

"Metal deficit in 2013 for the first time in five years ... Insufficient new mine supply to replace closures ... Chinese mine supply will determine market fate ... upside surprises unlikely."

Adding to the excitement is the steady ratcheting up of tightness across the front part of the LME curve.

The benchmark cash-to-three-months period CMZN0-3 has in the last few days flared out to levels of backwardation not seen in years, closing Tuesday valued at $26.25 per tonne.

No wonder short position-holders are now scrambling to cover or to escape the squeeze by rolling further along the curve.

Well, most of them at any rate.

Because one of the most interesting features of the current LME zinc dynamic is the really large short position holding steady station on the March prime date.

A COMPLICATED RELATIONSHIP

The front part of the LME zinc curve has been in and out of backwardation since the middle of December.

There is no obvious reason for this.

The global market may have moved into supply deficit last year but only after five years of surplus and associated stocks build.

LME stocks have been falling but at almost 752,000 tonnes are still high in outright terms.

For sure, zinc has been caught up in the LME load-out queue machinations with tonnages concentrated in problem locations such as New Orleans, Detroit and Vlissingen. <0#MZNSTX-LOC>

But what should be the key criterion for availability, open tonnage, looks relatively healthy at 576,400 tonnes.

Compare and contrast with the other two LME contracts currently experiencing front-date tightness; tin and copper.

Tin stocks are historically low in outright terms and have been for some time now. Copper stocks are evenly split between cancelled and open tonnage. At 134,100 tonnes the latter is at a level that in the past has been synonymous with cash-date squeezes.

But then the relationship between zinc stocks and spreads has always been more problematic.

That relationship, according to Leon Westgate, analyst at Standard Bank London, "isn't quite as coherent as many of the other base metals with regular periods of backwardation occurring at varying stock levels." ("Commodities Daily", March 4, 2013)

"Even looking at pinch point effects, zinc appears to have a much more complicated relationship between inventory levels and near-dated spreads than most if not all the other LME metals."

POSITIONING

The LME zinc tightness, Westgate concludes, "looks to be related to positioning" rather than non-availability of metal.

Which brings us back to that March short.

At 30-40 percent of market open interest (as of Monday's close), it is a mega position, equivalent to between 518,000 and 691,000 tonnes.

It has been there for many weeks and, as this month's prime prompt date of March 19 moves closer, shows no sign of shifting.

Indeed, the current structure of the nearby zinc curve suggests it is other players holding closer-dated short positions that are feeding the backwardation.

The cash-March 19 spread was valued at $14 backwardation on Tuesday. March-April, which should be the most sensitive spread to any movement out of this month's prompt date was, by contrast, valued at "just" $5.5 backwardation.

******************************************************* Graphic on LME zinc curve structure: link.reuters.com/syd47v *******************************************************

Aligned against the March short are four sizeable long position-holders, according to the LME's latest futures banding report <0#LME-FBR>

Some sort of showdown looks increasingly likely, promising what the LME "Street" likes to call "fun and games" and everyone else would call a potentially bloody bust-up.

STAND AND DELIVER?

Unless, of course, that short has no intention of trying to escape but rather is planning to physically deliver metal into the LME system.

Something similar happened in January, which also saw spread tension build in the early part of the month.

A total 57,025 tonnes of metal sitting in the load-out queue at New Orleans was re-warranted either side of the January prime prompt.

That's one reason why open tonnage in the LME storage system has steadily increased from 500,800 tonnes at the start of the year even as headline stocks have fallen.

It's happening again right now. The stocks report on Wednesday morning showed a net movement of 4,775 tonnes from the cancelled to the open category.

But it is highly questionable as to whether the March short is in the load-out queue, given its size relative to the reduced amount of cancelled tonnage now in the system.

The potential seems to be there for a wholesale delivery of metal that is sitting off-market back into the visibility of LME storage.

THE MISSING LINK

Which touches on the missing link in the zinc bull story. Where, exactly, has five years of cumulative surplus gone?

Some of it is there in those high LME stocks. But more of it isn't. Has it gone to China, as some analysts argue? Or is it still sitting gathering dust closer to an LME home, locked up in a financing deal?

In this respect the LME queues have served only to deepen the gloom.

Antwerp, for example, saw 156,400 tonnes of zinc warranted in the space of a single month, October 2012. Registered tonnage in the Belgian port peaked at 179,800 tonnes in February 2013, by which time most of the metal had been cancelled to form a load-out queue.

Antwerp now holds just 3,750 tonnes of LME-registered zinc, begging the question as to what happened to the rest of it.

We may be about to find out.

The LME zinc tightness appears to reinforce the bull narrative driving this market higher. It may, though, turn out to pose a major challenge to that narrative, if it acts to remind everyone that five years of surplus stock hasn't miraculously vanished. (Editing by David Evans)

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