Commodities | Jun 17 2010
By Chris Shaw
Even in an environment of improving economic news over the first few months of this year, zinc and lead prices have been falling to the extent both metals are trading at levels where most producers are scarcely breaking even.
Zinc and lead prices have a strong connection given the two metals tend to appear together in nature and so are often both produced from the same mine.
Research group and portfolio manager Hallgarten & Co suggests the price weakness in these metals has some implications, a major one being the weakness in price of both metals is responsible for little in the way of new projects. Rather than being developed, these new projects are being left on drawing boards, at least until prices recover to more profitable levels.
In the view of Hallgarten analyst Christopher Ecclestone, this stalling in new project development is a negative for long-term supply, given the long lead time required to take a project from the proposal stage to being in production. The positive of this is additional support for longer-term prices, as any supply side response will be weaker than previously expected.
For zinc specifically, Ecclestone notes at a price below US70c per pound most producers are losing money. This means price action in recent months has been something of a surprise, as while steel production has rebounded in 2010 there has not been anything like an equivalent bounce in the zinc market. This reflects relatively weak Western demand.
On Ecclestone's numbers, zinc demand in 2009 fell by 25% in Europe, 10.5% in the US, 23% in Japan and 22% in Korea, which offset an increase in Chinese usage of 17.8%. On balance he estimates global demand fell by 5.3% last year.
This meant for 2009 production of refined zinc exceeded usage by 445,000 tonnes, which was the largest surplus since 1993. Ordinarily such a surplus would have sent prices even lower, but Eccelstone notes China took advantage of price weakness to increase its stocks of the metal.
Global zinc production is expected to increase in 2010, but the key for Ecclestone is this is likely to prove a short-term issue as global mine production should then fall in both 2011 and 2012. This is the fallout from a lack of new mines coming on stream to replace expiring mines.
Why Ecclestone is bullish on zinc has much to do with China, as having been a large next exporter early this decade the Chinese in the last couple of years have swung to being large scale importers. Such a trend is expected to continue, as China's ongoing energy supply problems are likely to see even more finished metal being imported.
The other issue in China is not only is the country's output not enough for its own needs, but what is produced in China tends to be higher cost thanks to low grades and mining inefficiencies. Ecclestone estimates while break-even for Western producers is somewhere around US80c per pound, in China it is closer to US$1.20 per pound. Chinese producers are therefore making large losses on zinc production at current price levels.
Foreign exchange movements are continuing to impact on producers outside of China. As an example, Ecclestone points out late in 2009 the Australian dollar was close to parity against the US dollar but is now trading at around US82c.
This decline against the greenback has allowed Australian producers to retain some margins, though overall they are worse off from the falls in the zinc price in recent months. In contrast, the European producers have enjoyed a net gain from the slump in the euro, the dream scenario for them being a recovery in the metal price while the euro stays below US$1.30.
In terms of who was selling as prices slumped this year, Ecclestone suggests the decline from US$1.20 to US$1.00 per pound for zinc may have seen some releasing of stock by the Chinese given their heavy buying at lower prices.
As prices slid below US$1.00 per pound however, Ecclestone suggests the Chinese would have been unhappy, as prices at this level would impact on future mining plans in that country. The slide in the zinc price to US71c per pound was simply distressed selling in his view.
With respect to the price outlook, Ecclestone suggests this distressed selling has now run its course, as evidenced by prices climbing back to the US80c level rather quickly. At these levels Ecclestone expects the Chinese will again look to enter the market to acquire some cheap stock, which would offer them some protection in case the market was to again overheat at some point.
In Ecclestone's view both zinc and lead prices could trade back at the US90c per pound level in the next few weeks and should finish the year at better than US$1.00 per pound in both cases. On a 12-month view zinc is expected to reach US$1.10 per pound or a little higher.
ASX-listed companies with direct leverage to the zinc price include Intec Ltd ((INL)), Prairie Downs Metals ((PDZ)), Abra Mining ((AII)), Kagara ((KZL)), Perilya ((PEM)), CBH Resources ((CBH)), Terramin Australia ((TZN)), Meridian Minerals ((MII)), Zinc Co Australia ((ZNC)), TNG Ltd ((TNG)), Overland Resources ((OVR)), Union Resources ((UCL)), Tri Origin Minerals ((TRO)), Metals Australia ((MLS)), Blackthorn Resources ((BTR)), Jabiru Metals ((JML)), Rox Resources ((RXL)), Anglo Australian Resources ((AAR)) and Bass Metals ((BSM)).