Long term zinc prices look good but the short term remains shaky

The latest edition of the Fortis Bank Nederland/VM Group Metals Monthly report paints an interesting picture of zinc demand toward 2016 with China squarely at the centre but suggests a case for some caution in the short term

Author: Geoff Candy
Posted: Wednesday , 24 Mar 2010

GRONINGEN -

Zinc prices should not be as high as they are at the moment if one considers only the short term fundamental picture.

This is according to the March edition of the Fortis Bank Nederland/VM Group Metals Monthly publication. According to the report, the one way ride that took three month LME zinc prices up by 125% last year could well come to an end in 2010.

"Our estimate that the three-month price will average $2,217/t in 2010 belies the acute volatility we expect will shape the base metals' markets this year, with zinc in particular being vulnerable," the group says, pointing out that a considerable amount of idled zinc supply has been restarted over the last few months, despite demand outside of China remaining largely uninspired.

The group believes that, while such a development should point to price weakness, the continued firmness in zinc prices is the result of the "new dynamics" that have come to shape base metals markets in recent years "with investor-driven demand based on expectations of tighter market conditions ahead, keeping prices above equilibrium."

The downside of the continued higher prices however is that, according to the report "The elevated price level could create an environment whereby miners and smelters are encouraged to ramp-up supply way more than is justified by current physical demand, threatening that the zinc market surplus remains high in 2010, at approximately 325,000t, against some 690,000t in 2009."

The report says mine production is estimated to rise by as much as 6.4% on year-ago levels, to 11.71 Mt. This is as a result of the restart of a number of operations and new sources of supply coming on stream. Fortis Bank Nederland and the VM Group add that refined production will rise by a more modest 3.4%, to 11.54 Mt, although capacity will rise considerably more, due to smelter expansions and new Chinese facilities.

"Global demand meanwhile will grow by about 7% year-on-year, to 11.2 Mt, as the Chinese construction and automobile sectors continue to flourish under Beijing's stimulus package and relatively loose monetary policies, and while OECD economies emerge from the gloom of 2009."

THE LONGER TERM

The thesis put forward in the article is that prices are being bolstered at levels higher than the short term fundamentals suggest because investors are looking through the current situation to the likelihood of significant market tightness further out.

According to the report, the expectation is that the zinc concentrate and refined markets are heading for sizeable deficits after 2011, as demand grows rapidly in emerging economies and numerous mines reach the end of their life, with little new committed supply in the pipeline.

"Maybe this long-term demand growth view will prove to be correct, although it is basing itself almost entirely on the view that emerging market growth - particularly in Asia - will continue its recent trajectory. Demand growth from the US and Europe ought to be largely discounted, since consumption rates between 2000-2008 have been either flat or in decline. Thus zinc's longer-term demand prospects lie with the rate of industrialisation in emerging economies."

And, while the group admits such assumptions are entirely plausible there are risks to the upside.

"Discounting 2009, China's zinc consumption has grown at an average annual growth rate of 13.5% since 2000. From 1.35 Mt in 2000, we estimate China will consume 4.5 Mt in 2010. In the event that China continues on this path, then by 2020 it could be consuming as much as 14.5 Mt of zinc - or 30% more than the world consumed in 2008."

But it adds, that supply constraints, and the possibility of tighter monetary policy could slow the rate of demand, before adding that "even on a much slower average annual demand growth rate of 5%, China will still be consuming 6.7 Mt of zinc per year by 2020."

Therefore it says, taking into account all the uncommitted and committed supply projects currently in the pipeline, "the zinc market profile therefore appears extremely tight going forward, especially in the period from 2012-2016. The zinc concentrate market, including all committed and uncommitted mine supply, has the potential to move into a surplus of more than 400,000t in 2013, but without uncommitted supply, or part thereof, this surplus would fall to just 100,000t. By 2014 we could be facing a zinc concentrate market deficit of as much as 500,000t, rising to ~3 Mt by 2016. This will depend on total smelter production capacity and utilisation rates, but here too we find a deficit against estimated consumption."

The report concludes then, that while the current higher market prices will likely encourage investment in new mine supply there will still remain a significant lag between initiation and production. And, it says, the recession has delayed much of this new construction.

"If the price stays high, then we foresee a rush to bring through new mine capacity over the next decade, or otherwise face a sustained market deficit. Current prices are therefore not without substance, despite near term fundamentals looking decidedly negative. We forecast zinc to average $2,825/t in 2011, $3,575/t in 2012 and ~$3,500/t in 2013. However, risk is to the upside, barring a double-dip scenario or some significant pause in the China growth story."