March 9, 2020 / 1:00 AM / a month ago

RPT-COLUMN-Funds hammer zinc as coronavirus compounds weak outlook: Andy Home

(Repeats Friday’s story with no changes to the text. The opinions expressed here are those of the author, a columnist for Reuters.)

* Zinc market supply-demand balances: tmsnrt.rs/32T5EKs

By Andy Home

LONDON, March 6 (Reuters) - The spread of the coronavirus has hit the entire London Metal Exchange (LME) base metals complex as fears grow over the demand shock travelling out from China.

Zinc has been hit the hardest of all.

At a current $2,010 per tonne, the London three-month zinc price is down by 13% on the start of January, the weakest performance in a weak pack.

Zinc touched a near four-year low of $1,970 on Feb. 28 and has struggled to stage a convincing recovery over the course of this week.

Funds have been piling into zinc on the short side. LME broker Marex Spectron estimates net speculative short positioning reached 32% of LME open interest on Tuesday, the largest collective bear bet since November 2015, when it peaked at 38% of open interest.

Meanwhile, in China the market “is running record shorts” on the Shanghai Futures Exchange (ShFE) zinc contract, Marex said.

Zinc’s problem is that the coronavirus has darkened further an already bearish outlook.

SHANGHAI STOCKS SURGE

Stocks of zinc registered with the ShFE have mushroomed from 28,054 tonnes at the end of December to 162,402 tonnes.

Inventory build over China’s new year holiday period is normal. The scale of this year’s build isn’t normal. It already exceeds the peak seasonal increases of 104,000 tonnes in 2019 and 91,000 tonnes in 2018.

Quarantine and restrictions on travel have worked to slow the post-holiday return to work, disrupting the zinc value chain in China.

Moreover, zinc is particularly exposed to the economic impact of the virus via its use in galvanised steel in the automotive and construction sectors.

China’s giant automotive market was already struggling before the coronavirus. Now it is collapsing.

Passenger car retail sales in China fell 80% in February because of the coronavirus epidemic, according to the China Passenger Car Association.

Globalised automotive supply chains mean that this is not just a Chinese problem but could affect other countries’ automotive output.

An UNCTAD report this week cited carmaker Honda as saying it would reduce vehicle output at two of its domestic plants in Japan’s Saitama Prefecture for a week or so in March due to concerns about parts supply from China.

The United Nations agency estimates a shortage of Chinese components caused a $50 billion fall in global exports last month, with the automotive industry one of the most affected.

Property sales in China have also collapsed, which may affect the sector’s ability to maintain construction and completion rates. That hits zinc due to its use in white household goods.

Some mitigation to this demand shock has come from disruption to China’s giant zinc production sector.

Henan Yuguang Gold and Lead, one of China’s biggest zinc and lead producers, has cut zinc output by 50%, or around 150,000 tonnes per year, because it has been unable to sell the sulphuric acid generated as a by-product of the smelting process.

Others have reduced operating rates or brought forward planned maintenance work to offset logjammed logistics affecting both their raw material and product chains.

The build in Shanghai stocks would probably be even more massive were it not for this supply-side offset.

ACCELERATING THE BEAR NARRATIVE

Unfortunately for the zinc price, China’s producers are likely to return to normal operations before the downstream sector, meaning further increases in both visible exchange and off-market inventory in the country.

The big commodity banks have had it in for zinc for many months basis a storyline of a market transitioning from a period of chronic mine supply shortfall to one of surplus.

This process has already played out in the raw materials segment of the zinc supply chain, with smelters enjoying treatment charges of over $300 per tonne in a saturated zinc concentrates market.

What the bears have been waiting for is tangible evidence that the raw materials surplus is travelling down the value chain to become metal surplus.

With non-Chinese smelter capacity constrained, all eyes were on Chinese producers to start lifting run-rates, which they did aggressively over the back end of 2019.

Inventory build in China was expected this year, but the coronavirus demand shock is now accelerating the process - witness the ballooning stocks on the Shanghai exchange.

So far, at least, the surplus is stuck in China behind the country’s export tariffs.

The last chapter of zinc’s bear story, the move to visible surplus outside of China, is still to play out.

LME STOCKS LOW

There has been only a modest rise in stocks of zinc held by the LME.

A flurry of deliveries onto LME warrant in February lifted headline stocks from 51,200 tonnes at the start of the year to the 75,000-tonne level.

But since then stocks have plateaued, even while available tonnage has edged lower due to a steady trickle of cancellations as metal is taken off-warrant prior to physical load-out.

These are still ultra-low exchange stock levels by any historical yardstick.

But the LME zinc spread structure has loosened dramatically over the last couple of weeks, the benchmark cash-to-three months spread CMZN0-3 flipping from a backwardation of over $20 in January to a contango of $19.50 per tonne as of Thursday’s closing valuations.

The spread is signalling there is ample metal available, even if it is not evident from the exchange’s own registered stock levels.

All the funds betting on lower zinc prices better hope this is a true signal rather than a hall-of-mirrors LME stocks reflection.

They have already paid the price several times for getting their bear timing wrong in the zinc market, with spreads flaring out as shorts rolled positions in the confines of limited LME stocks availability.

There are a lot of shorts in London. There is still very low stocks cover. The surplus is building in China, but until it becomes evident elsewhere, bears could yet be caught out again.

Editing by Jan Harvey

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