July 21, 2016 / 2:01 AM / 4 years ago

Zinc starts to bubble as investors pile in (again): Andy Home

LONDON (Reuters) - Zinc is this year’s investment pick of the base metals traded on the London Metal Exchange (LME).

Zinc dross, used in the production of galvanized steel, is seen at a workshop of the Novolipetsk (NLMK) steel mill in Lipetsk, about 500 km (311 miles) southeast of the capital Moscow, January 30, 2014. REUTERS/Andrey Kuzmin

The price of LME zinc for three-months delivery has risen by 42 percent since the start of January to a current $2,235 per tonne.

It is by a wide margin the strongest year-to-date performance among the LME pack and prices are now back at levels last seen in May last year.

Also rising at a fast clip, though, is speculative interest on both the London and Shanghai markets.

Market open interest on the Shanghai Futures Exchange (ShFE) is surging, while speculative length in the LME is rapidly approaching those May 2015 peaks.

Investment money is betting on zinc’s supply-side story of raw materials crunch, a stand-out in a sector still overshadowed by the overarching demand-side narrative of Chinese slowdown.

But timing this story has always been tricky.

Investors have got sucked into the zinc market before, most recently in May last year, when the London price peaked at $2,400 only to collapse back below $1,500 by the end of the year.

Is this time going to be any different?

Graphic on money manager positioning on the LME:

tmsnrt.rs/29Y7iSl

Graphic on Shanghai zinc price, market open interest and volume:

tmsnrt.rs/29Y7m4K

PILING ON THE BETS

Speculative length has been steadily growing in the London zinc contract, both reacting to and adding to the current strong price rally.

The LME’s own positioning reports show that money managers were net long of zinc to the tune of 73,928 lots, equivalent to around 18 percent of open interest, at the end of last week.

That’s the largest cumulative long position since May 2015, when it peaked at just over 100,000 lots.

The exchange’s commitment of traders report has many detractors for the way entities, particularly some of the larger ones, are classified.

However, an alternative take on speculative positioning from LME broker Marex Spectron, is painting pretty much the same picture.

Marex estimates the net speculative long position in LME zinc has surged by 13,000 lots over the last week to a current 28,000 lots, equivalent to 14.6 percent of open interest.

The methodologies may be different but the underlying theme is the same. Marex too estimates that this is the most speculative length in the contract since May of last year.

Something very similar is happening in the Shanghai zinc market.

Market open interest has risen to 508,000 contracts from just over 300,000 as recently as the middle of May.

It has exceeded current levels on just two occasions in the past.

The first was in the July-September 2014 period, when prices were also surging. The second was in November last year, when open interest and volumes spiked as prices fell, attesting to a collective bear raid on the market.

Volumes in this particular price up-cycle have been relatively subdued, suggesting no return of the retail crowd that roiled Chinese commodity markets in the first quarter of this year.

Rather, the inference is that the build in open interest in tandem with rising prices is mirroring the structural build in investment money in London without overly attracting the masses of day-traders that populate both Shanghai and other domestic exchanges.

TIGHTNESS NOW...

That zinc’s prospects are relatively brighter than most of the other London base metals packs is not really in doubt.

There is a hardening consensus that zinc is suffering from a hard-rock supply problem as some of the world’s oldest but biggest mines reach the end of their lives.

All the evidence is supportive of this thesis.

Global mine production slumped by 8.1 percent in the first four months of this year, according to the latest monthly statistical update from the International Lead and Zinc Study Group (ILZSG).

That has caused a drop in treatment charges, the amount smelters charge miners for turning their raw material into metal, as processors compete for supply.

Spot Chinese import terms, for example, have slid from $170 per tonne at the end of last year to around $100, according to Thomson Reuters GFMS.

That in turn has fed through to significantly lower Chinese imports so far this year. At 910,000 tonnes (bulk weight, not metal contained) they were down by 23 percent in the January-May period.

All of which reinforces the bull story of a fast-evolving concentrates crunch, albeit one massaged by Glencore’s continued idling of 500,000 tonnes of annual mined capacity.

...TIGHTNESS TOMORROW

The only problem is that these constraints don’t yet appear to have translated into the refined metal part of the supply chain.

So for example, Swedish company Boliden, which operates both mines and smelters, notes in its second-quarter report that “the market’s concentrate stocks are low and continued to decline during the quarter” but that “European spot market metal premiums have remained stable”.

Physical metal premiums should be the real litmus test as to when concentrates shortfall translates into metal shortfall.

Quite evidently, it isn’t happening yet and that is probably down to the amount of metal inventory, only partly visible, still sitting in warehouses around the world, but most particularly in New Orleans.

Some of it has been on the move, according to LME broker Triland Metals, which noted in its latest weekly physical premium report that “traders (are) shipping material from New Orleans to Asia to meet long term contracts demand”.

But equally there still appears to be sufficient metal sitting in what is the black hole of the refined market’s supply chain to feed 77,000 tonnes into LME stocks at the U.S. port over the second half of June.

TIMING

The route of travel in the zinc market seems clear. Its speed in getting there, however, remains highly uncertain.

That is why some players have opted for long-dated options as a way of playing the expected upside, in effect placing their bets on December 2016 and June 2017.

Plenty of others, however, are still expressing their bullish views in the form of the LME three-months price and shorter dated ShFE contracts.

Possibly too many of them.

Without confirmation, and soon, that the refined metal part of the supply chain is tangibly tightening, the current levels of open interest look like an accident waiting to happen.

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

Editing by Susan Thomas

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