(The opinions expressed here are those of the author, a columnist for Reuters)
By Andy Home
LONDON, Aug 11 (Reuters) - Zinc bulls, and there are plenty, have just received another lesson in the perils of timing.
One stand-out of the first Commitments of Traders report issued last week by the London Metal Exchange (LME) was the speculative positioning in the exchange’s zinc contract. At 30 percent of open interest, the collective long position held by money managers was the highest of any core base contract.
Even that figure may understate the true positioning landscape, given the potential for investment money to lie hidden in the catch-all “broker dealer/index tracker” category.
That money is there for a reason, namely zinc’s bull narrative of mine closures and a resulting shift from supply surplus to shortfall.
It’s an alluring story for investors chasing the next big thing in the metals space, and one that has been given added spice by a steady, daily flow of metal out of LME warehouses.
Except that stock flows have gone into sharp reverse over the last week.
It’s a useful reminder that LME inventory movements are often poor indicators of underlying market dynamics and, in the case of zinc, can actively distort collective perceptions.
Monday morning’s LME warehouse stocks report <0#MZNSTX-LOC> showed the warranting of 15,175 tonnes of zinc at New Orleans, bringing the cumulative inflow there to 62,425 tonnes since the last week of July.
It’s not the first time this has happened. There were two large tranches of warrantings, totaling almost 147,000 tonnes, at the same location in March.
Stocks had been falling daily since then, more than 120,000 tonnes departing in the intervening period. Or maybe that should read “departing”, since the sudden “arrival” of so much metal begs the question of whether all that zinc really left New Orleans or was being shuffled between on- and off-market storage.
Interpreting zinc stock movements at the U.S. port isn’t helped by the concentration of units at just two warehouse operators.
At the end of June, Pacorini, the warehousing arm of zinc market powerhouse Glencore, was storing 582,700 tonnes of LME-registered metal at New Orleans, according to the LME’s recently launched report on load-out times and warrant distribution.
The report does not break down that figure between metals but it is worth noting that the only other significant LME warehouse player in New Orleans is Metro, owned by Goldman Sachs , which held 84,050 tonnes of metal at the end of June.
Given there were 538,000 tonnes of registered zinc in New Orleans at the end of that month, it’s not rocket science to work out which of the two was holding most of that.
Remember also that New Orleans holds just under 84 percent of all the zinc in the LME’s global warehouse system.
What happens there inevitably colours perceptions about global market balance, even if stock movements may reflect only the warehousing dynamics of a single operator.
And what the broken downtrend in New Orleans zinc stocks appeared to be signalling was deficit now, a piquant counterpoint to this market’s underlying story of deficit tomorrow.
The monthly statistical updates from the International Lead and Zinc Study Group (ILZSG) also suggest a current market supply deficit.
But drill a bit deeper into the group’s calculations and it’s clear that the deficit is all in China, with the rest of the world still assessed as being in a 138,000-tonne supply surplus in the first five months of this year. The surplus is contracting. It was calculated at 244,000 tonnes in the same five-month period of 2013. But surplus is still surplus.
Meanwhile, China’s assessed 332,000-tonne supply deficit in January-May also comes with a big caveat.
ILZSG uses an apparent consumption calculation, meaning what China imports is counted as consumption. Those imports, however, may simply reflect stocks redistribution if the metal is travelling no further than a bonded warehouse as part of a collateral credit financing deal.
Analysts at Goldman Sachs are the latest to flag the deceptiveness of this import flow. They argue China has “over-imported” around 200,000 tonnes of zinc this year, all of which has gone into bonded warehouses, where stocks have risen to 240,000 tonnes from 40,000 tonnes at the end of last year. (“Zinc price overshoots its short-run fundamentals”, July 31).
Strip that tonnage out of ILZSG’s deficit calculation and the Chinese and global pictures start to look very different.
Moreover, as Goldman points out, the potential for Chinese zinc imports to maintain their current rate, 375,000 tonnes in the first half of 2014, is dubious, given banks’ new caution about such collateral deals after the double-counting scandal at Qingdao port.
As the title of that Goldman Sachs research note suggests, the bank is still bullish on zinc’s prospects but only over a longer timeframe.
“Overall, we forecast a balanced market in 2014 while seeing a deficit emerging in 2015 and 2016 which is the key to determining our unchanged 12m price forecast of $2,500/t.”
LME benchmark zinc had almost got there in the first days of August, three-month metal trading above $2,400 per tonne, having risen 13 percent since early June.
The rally was fuelled by speculative money and predicated on a perception that the market had already shifted to supply deficit.
That perception has just been severely dented by all the metal flowing in, or maybe back in, to LME storage sheds in New Orleans.
Some investors have already voted with their feet, judging by last week’s pull-back to below $2,300, but that’s still a rich price for a market that is at best balanced against a backdrop of high global stocks.
Others in the bull camp will have to relearn the old LME trading lesson that LME stock movements can be more smoke-and-mirrors than a true market indicator.
One day, they may well be rewarded with real market tightness as those mine closures bite supply.
Just not yet, apparently.
Editing by Dale Hudson