May 13, 2019 / 1:03 AM / in 10 days

RPT-COLUMN-Differing outlooks will reinforce zinc and lead divergence: Andy Home

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

* LME Zinc and Lead: tmsnrt.rs/2WBTa5N

* Zinc Market Balance: tmsnrt.rs/2WFfBaA

* Lead Market Balance: tmsnrt.rs/2WAgH7n

By Andy Home

LONDON, May 10 (Reuters) - Zinc and lead may be so-called “sister” metals but their price divergence has rarely been wider.

At one stage last month London Metal Exchange (LME) zinc commanded a premium of $1,003 per tonne over lead, the widest pricing gap in 12 years.

The estrangement is odd given the two metals share the same supply driver. Most zinc mines produce lead as a by-product. The raw materials squeeze in zinc has inevitably caused a mirror-image squeeze in geological sister lead.

Yet London zinc is up 9% so far this year at a current $2,624 per tonne, while lead has fallen 6% to $1,833 per tonne, making it the weakest performer among the London-traded base metals.

This week’s biannual forecasts from the International Lead and Zinc Study Group (ILZSG) will likely reinforce the divergence.

Forecast fundamental divergence will, in turn, reinforce fund divergence, hardening very different investor views of the two markets.

A TALE OF TWO SISTERS

Both zinc and lead markets registered refined metal supply shortfalls in 2017 and 2018, according to ILZSG.

But their fundamental fortunes will differ this year, according to the Group’s latest statistical assessment.

Zinc is expected to remain in supply deficit to the tune of 121,000 tonnes, while lead will revert to a forecast 71,000-tonne surplus.

Zinc’s narrative has turned from raw materials famine to feast but the kink in the tale comes in the form of a smelter bottleneck, particularly in China.

ILZSG’s forecasts capture that picture with global mine supply seen rising 6.2% this year but refined metal production up only 3.6%. European production will fall by 0.8%, reflecting the permanent closure of Russia’s 100,000-tonne-per-year Vladikavkaz plant in October 2018.

Even with a fairly anaemic usage outlook of 0.6%, that still leaves a supply gap.

Timing when that gap closes is proving a tricky trade, particularly in the LME hall of mirrors. Registered stocks have almost doubled since the start of April to 97,650 tonnes but time-spreads remain super-tight.

This morning’s LME stocks report, showing the cancellation of 9,000 tonnes of registered zinc at Rotterdam, is likely to exacerbate the pricing tension.

LME lead spreads, by contrast, have been trading in relatively benign contango with exchange inventories largely stable over the last two months.

Lead is unlikely to be shaken out of its price drift by ILZSG’s assessment the market is heading back to surplus after two years of deficit.

Global refined lead production is expected to rise by 2.5%, outstripping demand growth of 1.2%. Global demand will be restrained by a forecast 1.1% decline in Chinese usage.

Hardly the stuff to excite your average fund manager looking for a bit of metallic fun.

FUNDS DIFFERENTIATOR

Not that lead is the sort of market to attract heavy-weight investment money anyway.

Although the lead acid battery sector is a recycling success story with European and North American recycling rates close to 100%, it’s a metal that carries a heavy historical burden of toxicity.

Popular perceptions of legacy lead poisoning linger, a reputational hazard for funds at a time of rising investor concern about environmental and social issues around the metals supply chain.

Moreover, for the adventurous fund manager lead is a notoriously difficult market to read. Even by the opaque standards of industrial metals, too much of the lead market is submerged in the statistical murk of the secondary sector.

Precisely because of the high battery recycling rate, more than half of global lead supply comes from recycled material.

Lead is a statistical iceberg. The bit you can see and count, mine supply, is underpinned by a larger scrap component that is largely invisible.

Fund money therefore prefers to play the zinc market, particularly on the long side. Not only are there more meaningful numbers to crunch but it is a more liquid market both in London and Shanghai.

The strong price divergence between the two metals over the last two years has largely been down to zinc’s out-performance, which in turn has been down at least in part to investor participation.

Funds and fundamentals combined to propel zinc to a decade high of $3,595.50 in February 2018.

It has since crashed and partially bounced back as shorts got caught out by the continued squeeze on metal availability.

RELATIVE VALUES

Lead’s role in all this has been that of whipping-boy in a relative-value trade with zinc. If funds are interested in lead at all, it is to go short while buying zinc.

The relative-value trade between the sister metals has been popular on the LME for many years and it remains so.

It has itself become a sporadic price driver, particularly for hapless lead, the junior partner in this family dance.

That seems unlikely to end any time soon, which means the spread between the two metals is going to remain beholden to zinc’s short-term fortunes.

Zinc is sinking again with shorter-term funds attacking a deteriorating technical picture in London and bears seemingly massing in Shanghai.

The continued spread tightness in London is a warning flag and the transition time from mine surplus to surplus metal remains a hotly-disputed question.

Shorting zinc is Citi’s preferred trade-war metals trade, since “zinc’s near-term window of tightness would slam shut on further global demand weakness.” (“Commodities Weekly”, May 6, 2019).

Analysts at Wood Mackenzie are sticking with their call that zinc will revisit last year’s highs before the end of 2019 as smelter performance lags expectations and stocks are drawn down to historical lows.

Amid such differing views it looks like zinc is in for a continued torrid time, which means that lead is probably in for one too.

Could lead spring a surprise on its bigger sister? It has traded at a premium to zinc in the past, most recently in early 2016.

It’s hard to see how, short of a major supply shock.

And if the shock comes from the opaque darkness of the secondary lead supply-chain, you won’t see it coming.

Which is, as far as many investors are concerned, the problem with lead.

Editing by Louise Heavens

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