Zinc’s star is burning ever more brightly as the year progresses. While other base metals traded on the London Metal Exchange (LME) continue to struggle against the headwinds of slowing Chinese growth and a stronger US dollar, zinc has notched up gains of over 21% since the start of January.
Investors have been drawn in by a narrative of mine closures and a resulting tightening of the raw materials supply chain. There have been plenty of false dawns in this market but this is the year that it really seems to be happening.
The International Lead and Zinc Study Group (ILZSG), for instance, estimates that mine output outside of China contracted by 9.5% in the first quarter.
Now there are signs of tightness creeping into the London refined zinc market, with cash metal commanding a small $2.00 per tonne premium over three-month prices over the last couple of days.
This would appear to reinforce the bull story but it may also be a test of that story, since past bouts of technical tightness in the London contract have drawn in large tonnages of previously invisible inventory.
And just how much zinc is “out there” to cushion falling mine production has become the major unknown hurdle to sustained higher prices.
The driver of a tightening London market is the ongoing decline in registered LME stocks.
These currently stand at 384,050 tonnes, down by 82,250 or 18% on the start of the year, and now a long way off the peaks of 2013, when LME stocks were in excess of 1.1mn tonnes.
The downtrend, however, has been highly erratic with occasional flurries of “arrivals”, as off-market metal has been delivered into the LME system, particularly at the US port of New Orleans.
As often as not, these sudden reversals of the underlying downtrend have been triggered by tight LME spreads, which have incentivised metal to be brought out of financing cold storage and delivered against short positions.
And as often as not, such inflows have caused prices to deflate as investors realised that LME stock trends are only part of the bigger inventory picture. It happened in spectacular fashion in the third quarter of last year, when almost 250,000 tonnes of zinc were delivered onto LME warrant, just about all of it at New Orleans.
And it happened again in February this year, when 50,000 tonnes hit the exchange’s warehouse system, although New Orleans only accounted for 8,725 tonnes, the rest arriving at the Malaysian ports of Port Klang and Johor.
As February was the last time the front part of the LME curve went into backwardation, there is a clear danger that renewed tightness could generate the same sort of stocks movement.
The size of “invisible” stocks, sitting in statistical darkness in off-market sheds, is one of the key questions when it comes to understanding how and when a tightening raw materials market will translate into a tightening refined zinc market.
ILZSG itself estimates that total zinc inventory, including exchange-registered tonnage, metal held by China’s State Reserves Bureau (SRB) and “commercial stocks” held by producers, consumers and merchants, has declined from a peak of 2.2mn tonnes in January 2013 to 1.5mn tonnes as of the end of March 2016.
However, ILZSG like everyone else struggles to calculate tonnage that has gone missing from the trackable statistics.
From recent history at New Orleans, it is clear that there is a significant gap in the overall stocks picture.
Estimates as to the size of that gap vary substantially but the broad consensus is that it amounts to several hundred thousand tonnes.
Leon Westgate, analyst at ICBC Standard Bank and one of the more bullish analysts in the market, suggests that there might be 700,000-800,000 tonnes, an estimate which would be “toward the lower end of consensus estimates”. David Wilson of Citi also draws attention to the existence of substantial off-market stocks in China of “at least 500,000 tonnes”, not including the 254,000 tonnes estimated to be held by the SRB.
Total off-market stocks, according to Citi, might be between 2.5mn and 3.5mn tonnes, “equivalent to 9-13 weeks of consumption, a volume likely in our view to have a dampening effect on prices.”
What may be lying unreported in China is probably going to stay in China thanks to that country’s tax on exports.
The only time zinc flowed out of the country in significant quantities was in 2014 in the immediate wake of the Qingdao port scandal, which sent shock waves through the metal-collateral trade.
Even then the outbound flow of metal wasn’t enough to turn the country to net exporter for anything other than a couple of months.
What lies in and around New Orleans, however, is altogether different since it has been proven time and time again that metal will flow into LME warehouses during periods of spread tightness.


Andy Home is a columnist for Reuters. The views expressed are those of the author.