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Glencore’s cuts come back to bite zinc bears

PUBLISHED : Monday, 23 November, 2015, 2:29pm
UPDATED : Monday, 23 November, 2015, 3:31pm

The London zinc price touched a fresh six-year low of US$1,497.50 per tonne on Thursday.

Last month’s flurry of excitement after Glencore’s announcement of 500,000 tonnes of mine cuts had, it seemed, completely dissipated.

But those cuts were carefully calibrated to get maximum impact out of the supply chain and the tremors are starting to be felt, judging by the recent announcement of major production cuts by Chinese zinc smelters.

And it’s caught the many bears in this market on the hop. The London Metal Exchange (LME) three-month price has surged to a current $1,602 per tonne.

Zinc, like copper, has been coming under sustained bear attack from China, where Shanghai Futures Exchange (SHFE) volumes and open interest have been surging even as the price has been sliding.

Investment money elsewhere has followed suit. LME broker Marex Spectron estimates the collective speculative short on LME zinc is around 38 per cent of open interest. That’s the highest it’s been since June 2012 and funds are more bearish on zinc than on any other metal.

The irony is that the bears are attacking zinc just when there is finally some tangible sign of tightness creeping into the raw materials market. Tightness that is evidently starting to worry Chinese smelters.

Such a development has been something of a holy grail for zinc bulls in recent years, much talked about but always elusive.

Up to now that is.

One of the stand-out current features of industrial metals trading is the build in short positions on the SHFE. It’s happening in copper. It’s happening in aluminium. And its happening in zinc.

Both Shanghai zinc market open interest and volumes have soared in recent weeks and are now at their highest since the tail-end of 2014. Given that prices have simultaneously been falling, the implication is a massive build of short positions.

There’s been much head-scratching as to what exactly is going on in Shanghai. Is it a return of the long equities/short metals trade that was in vogue earlier this year? If so, it’s come back bigger and bolder than before.

Or is it just a collective negative assessment of China’s metallic prospects over the coming period with zinc picked out as being particularly vulnerable to further slowdown?

Certainly, the mood at last month’s China International Lead and Zinc conference in Xi’an was apparently gloomy, with delegates fretting about poor demand and high stocks, both of refined metal and concentrates.

Stocks of refined zinc are undoubtedly high both in China and the rest of the world. Look no further than New Orleans, where the zinc carousel is still turning.

LME warehouses received almost 240,000 tonnes of zinc over the course of August and September. So far this month almost 63,000 tonnes have been cancelled and are awaiting load-out.

The inference is that behind this visible shuffling of metal, a combination of spread and storage arbitrage, lies a bigger inventory mountain in the off-market shadows.

And as for concentrates, four years of rising benchmark treatment charges, the best indicator of raw materials availability, suggest four consecutive years of surplus, upon which smelters, particularly Chinese smelters, have feasted.

But that latter part of the equation is now changing.

According to Chris Parker, zinc research director at Wood Mackenzie, “spot treatment charges for concentrate imported into China in November 2015 fell in the range $185-190 per tonne.” The research house’s indicative treatment charge for this month is $190, basis delivery at major Chinese ports.

“This is a reduction of $20 per tonne from the peak of $210 in May-June 2015 and the lowest since $185 in September 2014,” Parker noted.

By way of comparison, this year’s benchmark terms were set at $245 per tonne.

Sliding treatment charges point to a tightening of availability and suggest downwards pressure on next year’s benchmark terms.

This was always on the cards, given the closure of two big mines this year, Century in Australia and Lisheen in Ireland.

In this context Glencore’s announced production cuts are now starting to act as an accelerator.

Moreover, more cuts may be on the way.

Belgian zinc producer Nyrstar, like many other metals producers, is scrambling to shore up a rapidly deteriorating balance sheet.

While its metals processing segment remains margin positive, its mining business recorded negative earnings (EBITDA) of 22 million euros in the third quarter and of 19 million euros in the first nine months of this year.

All options are on the table, including “additional suspensions, asset disposals and a full exit from mining”.

Nyrstar has already shuttered two of its mines, Myra Falls in Canada and Campo Morado in Mexico, and is now actively considering mothballing another 400,000 tonnes of concentrates capacity, or around 200,000 tonnes of metal contained, “if the current depressed commodity price environment continues.”

This accumulating loss of mined production, with the prospect of more to come, is now starting to unsettle China’s zinc smelters, which are collectively the world’s biggest buyers of raw materials.

Facing falling treatment charges, falling zinc prices and falling by-product prices, a grouping of the largest Chinese smelters have now indicated their intention to slash output by 500,000 tonnes next year.

As ever with China, it remains to be seen whether words translate into action but the significance of the news is what it says about the squeeze on smelter profitability. A squeeze which will only become more acute if treatment charges, a key revenue driver, continue sliding.

In short, this is precisely the scenario that has so inflamed bullish hopes in recent years. Those hopes have been regularly dashed as mines such as Century managed to keep going way beyond their expected expiry dates and large volumes of metal disappeared only to reappear in New Orleans.

And now it’s happening, just as the massed bears both in China and the rest of the world direct their collective fire power on the zinc price.

True, none of what is happening in the raw materials section of the zinc market will affect overnight availability in the refined part of the market. And there is no doubt that there is a lot of stock overhang to cushion any flow-through impact.

But those Glencore cuts, so readily discounted by the market over the last few days, were always carefully targeted at the most sensitive part of the zinc supply chain.

Just how sensitive we are now starting to understand.