Chen Yuan: Zinc prices under downward pressure, limited space for lead prices to rise or decline

Asian Metal: Zinc prices increased recently, with LME zinc prices in particular demonstrating a strong trend and recording a new three-year high in July. What do you think are the reasons for the price increases and how long is the upward trend likely to persist?

Chen: The zinc market data issued by the ILZSG in mid-June were very strong. On the one hand, a severe shortage in supply still existed on the global zinc market with a deficit of 10,700t for refined zinc during January-April; on the other hand, the growth rate of global zinc ore output was slowing down. The steady growth of demand in China, the zinc market recovery in other nations and, most importantly, the increase in Chinese financing zinc import demand, all contributed to the shortage in supply. As for the zinc ore market, the number of zinc mines globally had seen a growth rate of about 2.5-4% over the past five years, but data issued in June indicated that the growth rate of global zinc ore output was only 0.4% in January-April. The Canadian Brunswick Mine, with an annual output of 250,000t, shut down after Q2, 2013; furthermore, some Chinese zinc mines also saw lower output in the first few months of this year, mainly because of the fact that mines were reluctant to resume operation on the back of environmental inspections and lower prices for lead, zinc and silver. As a result, the global zinc ore output in January-April declined year-on-year.

In addition, the zinc concentrate output in China also dipped unexpectedly, with a drop of 4.89% year-on-year for the period between January and May, according to data from the National Bureau of Statistics. I believe the lower zinc ore output was mainly caused by stringent environmental protection and low lead, zinc and silver prices. As far as I know, some small zinc ore mines in Yunnan were closed down or maintained low operation rates earlier this year due to low lead-zinc prices, while some mines in Hunan ceased production due to environmental protection cases.

I think the zinc concentrate supply shortage is set to worsen in the near future, should zinc prices remain at low levels. The zinc price is decisive when it comes to a zinc ore supply shortage. The shortage may become more severe in the international market moving forward as mines will be less active in production and expansion if zinc prices stay below USD2,100/t. Stimulated by higher zinc prices, some mines will resume or enlarge production, so in this case the supply shortage would be lessened in the future.

The recent round of zinc price increases was not a sign of tight supply for zinc concentrate in the international market or domestic market at the moment, it was just a consequence of an anticipated larger supply shortage of zinc ore in the near future. The fluctuation in zinc prices at the LME was probably a bit quicker than actual supply and demand changes. Zinc prices may rise moderately when they are at low levels. Higher prices can stimulate capacity expansion and maintain the production of some capacity with high costs. Zinc prices have been low with no sign of declining since last year, so it is extremely safe for investors to invest in the metal, showing that zinc is a favorable entity for investing. Some enterprises who were bullish about the zinc market started to actively replenish zinc ore earlier this year.

Asian Metal: When contacting both foreign and domestic clients, we have found that overseas clients are generally optimistic about the zinc market outlook, while those at home are relatively cautious. In addition, financing companies across China are the most optimistic about the zinc market, then come traders, with zinc ingot producers and consumers the most cautious.

Chen: From the point of view of the industrial chain, there is not much positive news on the international zinc ingot market. Domestic zinc ingot stocks continue to decline while demand hasn’t grown any stronger and supply remains abundant. Overseas players are more sensitive about the market as most of the zinc mines which have shut down recently are foreign enterprises. In this situation, the zinc market generally sees ‘bear’ in China, while ‘bull’ dominates in foreign countries. The tightening supply of zinc ore globally is helping to push the market up. What’s more, some investors have engaged in taking long zinc on the LME since the beginning of 2014.

Asian Metal: Zinc ingot stocks both on the LME and the domestic market are decreasing. Is this a sign that demand will increase?

Chen: Zinc ingot stocks have been at low levels in China since the beginning of this year. Limited by capital flow, upstream and downstream enterprises will not leave much material in hand. Besides, players didn’t have any confidence in zinc prices previously and most smelting plants showed little interest in additional purchases when zinc prices increased to around RMB15,500/t.

After a three-year decline, domestic zinc ingot stocks have been depressed to a level last seen in H1, 2009. Given the downstream consumption levels, I suspect Chinese zinc ingot consumption would have kept increasing with a stable growth rate. Although the growth rate is a little slower this year, it has still reached about 5%. So it has not been hard to see the limited zinc ingot supply in China over the past few years.

As for the decrease in zinc ingot deliveries in China, the lower operating rates and reduced output seen in domestic zinc smelting plants are likely to be part of the reason. Those plants mainly relied on secondary products rather than zinc ingots, the main product for gaining profits previously, so when the prices of secondary products dropped recently, their profitability declined noticeably. Limited imports of refined zinc are the other reason. According to customs data, imported refined zinc increased by more than 20% year on year in China, but most of these materials stood in bonded areas rather than coming into domestic markets. The rate of zinc prices on the SSE against those on the LME reached 7.6 this year and the premium on imported zinc was only around USD150-160/t, lower than the USD180/t in the same period last year.

Judging by the current zinc price ratio of SSE to LME and premiums, few profits are being made in imported zinc ingots, and such a large export volume is mainly reliant on financing demand. According to data released by Macquarie, the stocks of refined zinc in bonded areas of Shanghai totaled 50,000t at the end of 2013, while the figure was 240,000t at the end of May 2014. Banks have tightened their limits on issuing credit, impacted by investigations in the bonded area of Qingdao, and China’s financing demand for imported refined zinc will weaken in the coming months, which may result in reduced import volumes for the metal in China.

Asian Metal: Domestic zinc smelters mostly reported no signs of significant improvement in the zinc market fundamentals, despite the surge in LME zinc prices. Will weak fundamentals in the Chinese zinc market inhibit any uptrend in the prices?

Chen: Price upticks in the domestic market are lagging behind LME zinc prices as speculation and expectations over figures are based on the overseas markets. Domestic zinc smelting capacity remains excessive with massive idle productivity, and the price hike of zinc is expected to drive up operating rates at domestic zinc smelteries. The increase in output is not limited by supply of raw materials, supported by sufficient supply of zinc concentrate domestically, and hence supply of zinc ingots will be under great pressure in the country. The operating rate of Chinese zinc smelteries was around 70% in June and may be close to 80% in the near future.

Asian Metal: What are your expectations for the zinc market in H2, 2014 and 2015?

Chen: I forecast a slight falling back in LME zinc prices. If zinc prices continue rising to new highs, the short-term market fundamentals will suffer. LME zinc prices will be strongly supported and stand at USD2,100/t in the short term. Demand for zinc ingots will remain weak in China before September, but the operating rate of zinc smelters will increase gradually. Appreciation in zinc will improve supply of zinc ingots. Therefore, domestic zinc prices may rebound significantly, and I am hopeful demand will pick up in September or October, but the figures are more likely to fall back on weaker demand in November or December.

Asian metal: Lead and zinc are very closely related as they are concomitant within the minerals. But now that there are rumors that foreign lead zinc mines are reducing or suspending production and there is an absence of lead supply in the international market, why have lead prices been experiencing stagflation? And why has the domestic lead market, in particular, not shown signs of following suit with rising prices?

Chen: There is a difference between lead at home and abroad. Lead prices on the LME have maintained a strongly positive trend over the last two years as demand for lead ingots increased with extreme weather overseas, while supply of lead scrap was tight. However, lead prices on the LME have been fairly low this year as lead demand in the foreign market is still relatively weak, along with an abundant supply of spent batteries. 70% of the raw material for refined lead is lead scrap, so the shutdown of lead and zinc mines has had a limited impact in terms of boosting LME lead prices.

Limited supply of lead concentrate provides strong support for lead prices in the domestic lead ingot market, but downstream enterprises in the lead industry are concentrating their strong bargaining powers on suppressing movements in lead prices in the future. Meanwhile, deals are rarely concluded in the domestic lead ingot market, narrowing any increases in lead prices.

Asian Metal: What do you think of the outlook for the domestic lead concentrate and lead ingot markets in H2?

Chen: The lead concentrate market is expected to remain tight in H2, as the limited narrowing between lead prices in the domestic and overseas markets has failed to improve lead concentrate exports significantly. In addition, mines are showing little interest in producing lead and silver at low prices. However, this support may be offset by the replacement of regenerated refined lead.

The output of secondary lead is increasing in the domestic market, accounting for more and more of the total refined lead output in China. Car ownership in China has now reached an all-time high, and the recycled volume of spent lead-acid batteries will increase moving forward, so the supply prospects for secondary lead are promising, but this is a negative factor for lead prices. To sum up, there is very limited space for lead prices to rise or decline in H2.