LONDON (Reuters) - Another 100 tonnes of zinc were loaded out of the London Metal Exchange (LME) warehouse system on Monday.
It wasn’t the most dramatic of moves but sufficient to reduce LME stocks to a fresh 12-year low of 58,325 tonnes - less than two days’ worth of global consumption and within touching distance of this century’s nadir of 58,100 tonnes recorded in October 2007.
Such desperately low inventory has rekindled zinc’s bull flames. The LME three-month price rose to an eight-month high of $2,882 per tonne last week, up 18 percent this year, before easing slightly to current levels of $2,800.
Time spreads remain tight and volatile but the premium for cash metal has so far failed to attract anything more than a smattering of fresh deliveries.
The persistent tightness of LME stocks is forcing a collective rethink about the outlook for zinc, particularly the much anticipated shift to supply surplus.
LME zinc stocks have fallen by 1.18 million tonnes from their 2012 peak.
The exchange’s stock reports have thrown up many surprises over the intervening years, with the downtrend sporadically interrupted by mass movements of off-market metal onto LME warrant, particularly in New Orleans.
But the New Orleans zinc round-about appears to have ground to a halt. The last significant inflow at the port was in October and there have been no arrivals at all this year.
The only zinc to enter the LME warehouse system in 2019 has been a highly modest 2,150 tonnes at the Spanish port of Bilbao and a single-lot delivery of 25 tonnes at the Belgian port of Antwerp.
Moreover, the headline LME stock figure includes 14,125 tonnes of metal earmarked for physical load-out, leaving just 44,200 tonnes of what are termed “open” stocks.
Between 80 and 90 percent of that is held by one entity, according to the LME’s latest report, with the size of the position prompting the exchange to enforce lending rules to limit the daily pain for shorts trying to roll positions forwards.
The benchmark LME time spread, cash-to-three-months, ended Monday valued at $36 per tonne backwardation. The cost of rolling a position overnight, the “tom-next” spread, was $3 at one stage this morning.
Short position holders should be grateful for the LME’s lending rules. Such low stocks would once have generated ferocious backwardations - where spot prices are higher than forward prices.
The widest backwardation so far in this chapter of the zinc story was the $125 traded for cash-to-three-months in November.
If the downturn in stocks grinds on toward zero, such extreme spread contraction may yet return.
LME stocks are only the visible tip of an industrial sector’s supply-chain inventory.
Traders, merchants and financiers can hold stocks off market in cheaper non-exchange warehouses. Stocks can be in transit or sitting in China’s bonded warehouses.
Assessing the size of such “gray” inventory is by its nature a tricky exercise.
Analysts at ICBC Standard Bank have posited a figure of around 650,000 tonnes, including 230,000 tonnes of onshore and bonded Chinese stocks. (“Zinc - Where is the metal?”, Feb. 18, 2019)
However, it’s becoming increasingly clear that if there are some 400,000 tonnes of off-market stocks outside of China, the owners are not interested in delivering them to an LME warehouse, at least not at the current cash premium incentive.
Compare and contrast that with the LME copper market, where stocks had also fallen to extremely low levels, pushing spreads tighter.
The broader availability of copper was amply demonstrated by last week’s 80,000-tonne surge of deliveries into the LME system.
The broader availability of zinc is being tested and found wanting.
That there is zinc in China should not be surprising given the country’s strong imports of refined metal. Last year’s tally of 713,355 tonnes was the highest ever and the second consecutive year of record imports.
Rising zinc stocks on the Shanghai Futures Exchange (ShFE) — up by 103,935 tonnes since the start of January to 124,038 tonnes — would seem to signal a replenishment of China’s own depleted supply chain.
Appearances can be deceptive, however.
ShFE stocks always rise over the first couple of months of the Western year, reflecting a seasonal low point for manufacturing demand and the Lunar New Year holidays.
Last year’s seasonal build was 90,000 tonnes to the end of March, providing some perspective on this year’s increase.
China shows every sign of being in a deficit market, where imports plug supply gaps.
Raw material from new and reopened mines should be boosting the country’s smelters as treatment charges have soared to over $200 per tonne for refining mined concentrate into metal.
Yet Chinese production keeps falling. National refined zinc output slid 3.2 percent last year and was down another 8.2 percent in the first two months of this year, according to the official statistics agency.
The need to comply with ever tighter environmental regulation is acting as a powerful counterbalance to the financial incentive to maximize production.
This smelter bottleneck is preventing new mine supply translating into better refined metal supply.
The time-line for zinc’s return to market surplus keeps shifting.
ICBC Standard expects the concentrates market to return to balance this year before heading into surplus in 2020.
However, the refined market will remain in deficit to the tune of 100,000-200,000 tonnes this year, split between surplus outside China and a large 600,000-700,000-tonne shortfall in China itself, according to the bank.
“We therefore expect the SHFE-LME (arbitrage) to remain open for much of the year, pulling international metal and concentrate into China,” it said.
If ICBC Standard is right, the LME zinc contract is going to have to get used to such paltry stock levels.
Which means it’s also going to have to learn to live with the resulting time spread tightness.
Backwardation could be here for a while.
(The opinions expressed here are those of the author, a columnist for Reuters.)
Editing by Kirsten Donovan