* LME zinc stocks now falling

 * Unprecedented surge of metal into China

 * Concentrates market tightening

 * Can mine supply respond ?
 

 By Andy Home

 LONDON, May 1 (Reuters) - The LME three-month zinc price has
risen 18 percent so far this year, making zinc the third best
performer among LME base metals (after copper and lead).

 Which is somewhat surprising, since the International Lead
and Zinc Study Group (ILZSG) has just forecast the global market
will record a production-consumption surplus of just over
260,000 tonnes in 2009. [ID:nLN957124]

 It will, moreover, be the third consecutive year of surplus,
following on a near-300,000-tonne surplus in 2007-2008,
according to ILZSG calculations.

 Why then the market's relatively exuberant year-to-date
performance ? Is it pricing in a much smaller surplus or even no
surplus at all ? The answer could well be a bit of both.

 VANISHING VISIBILITY

 LME stocks, as the most visible expression of market
balance, hold the key to what is currently going on in the zinc
market.

 LME inventory rose by 165,000 tonnes last year and surged
another 104,250 tonnes in the first two months of 2009, peaking
at 362,275 tonnes on Feb. 25.

 Since then, however, the flow of metal has reversed and
exchange-registered inventory has fallen by 33,325 tonnes to
328,950 tonnes. That represents a very modest 11 days' of
anticipated 2009 consumption. 

 Compare and contrast with the last peak in LME stocks in
April 2004. Back then they reached 787,150 tonnes, equivalent to
27 days' worth of global consumption. 

 A strong supply-side response to the collapse in demand has
played a big role in mitigating the sort of build seen five
years ago.

 As Nyrstar, the world's largest producer of zinc metal,
hailed in its just-released 2008 report, "the zinc industry
responded more widely, quickly and decisively than in previous
downturns to the sharp drop in zinc demand". Nyrstar itself
reported a massive 30-percent decline in first quarter 2009
production relative to the preceding quarter (Q4 08).
[ID:nLT544145]

 However, that is only part of the explanation for the change
of trend in LME zinc stocks. 

 The other part comes in the form of the surge in zinc metal
imports into China. The country's trade in zinc has been
extremely volatile in recent years but the current movement of
metal is unprecedented, as can be seen in the following graphic.

(here)

 Part of China's import tonnage has been drawn down from the
LME system. It's noticeable that the two key LME zinc locations
in Asia, Singapore and Johor, are both showing year-to-date
declines of over 10,000 tonnes. The two locations also account
for 17,800 tonnes of the total 20,200 tonnes of metal sitting in
the cancelled warrant category.

 As with other metals, most particularly copper, zinc is
benefiting from Beijing's industry support programme. The State
Reserve Bureau has bought up 159,000 tonnes and several regional
governments have announced their own mechanisms for helping
struggling zinc producers. [ID:nPEK324588] 

 As such, the movement of metal amounts to little more than
visible LME surplus being shifted to invisible non-LME surplus. 

 However, as also with copper, the drain on LME stocks is
impossible to ignore for LME traders, which is why neither the
red metal nor zinc particularly feels like it is in
supply-demand surplus.

 VANISHING SURPLUS

 However, it is not just zinc metal that is responding to the
open arbitrage between Shanghai and London. 

 Zinc concentrate imports are also rising, up 16 percent in
the first quarter of this year. Unlike zinc metal, this may be
material the Western market can ill afford to lose. 

 In its spring 2009 forecasts the ILZSG noted that global
mine production is expected to fall at a faster pace (6 percent)
than refined metal production (4 percent).

 This reflects the wholesale closure of marginal mines and
deferral of new projects in response to a zinc price collapse
that preceded the global financial turmoil of late last year.

 It will also leave the zinc concentrates market in small
(100,000-tonne) deficit, according to ILZSG.

 Spot treatment charges (TCs) for smelting concentrate are
already falling in response to this building tension in the raw
materials market and Nyrstar felt it worth stressing in its Q1
2008 management report that the decline in terms is due only to
the current arbitrage and "does not reflect a physical shortage
in the markets for zinc and lead concentrates."

 From the other side of the smelter-miner divide, however,
comes a slightly different view. In its Q1 report Canada's Inmet
Mining said that "we expect zinc mine production in 2009 to be
below smelting requirements, and believe that a balanced or
deficit zinc concentrate market could evolve."

 Zinc's problem going forwards is that mine supply may have
lost some of the elasticity to higher prices that was seen in
2006-2007, when multiple restarts filled the news headlines.

 Many of the junior operators that tried to cash in on the
bull market rally to over $4,000 were devastated by the timing
and severity of the subsequent crash, particularly since it
coincided with a severe constriction in credit availability.

 The likes of Canada's SRA, Blue Note Metals and Acadian
Mining were not only forced to drastically scale back or even
mothball recently-started operations but were sent reeling into
bankruptcy protection.

 At the same time several important established mines are
fast approaching the end of their lives. Sweden's Lundin, for
example, will bring forward to this year from 2011 the permanent
closure of its Galmoy mine in Ireland. Its Storliden mine in
Sweden closed permanently at the end of last year. 

 Xstrata's big (250,000-tonne) Brunswick mine in Canada is
also fast approaching the end of the road, currently pencilled
in for late next year.

 Right now none of this seems very relevant while demand is
still so bombed out. But the zinc price is begging to differ.

 That forecast 2009 metal surplus may look large but it is
fast disappearing into China, even while the raw materials
market looks in danger of swinging from surplus into deficit
before the year is out.