Is Zinc Outperformance Justified?Posted on 13 Nov 2020
By Richard Fowler, SSY Derivatives Analyst
Zinc has outperformed base metal peers so far this year and we look through the most recent data to ascertain whether the pace of price gains can continue.
China has been a key driver for metals this year and Chinese zinc demand has recovered well from having been pressured by virus-related restrictions and lockdowns. This recovery has been the result of a boost to infrastructure and construction sectors, which represent some two-thirds of Chinese zinc demand, from increased credit availability.
Recent credit numbers, as well as infrastructure new orders and equipment sales, such as the excavator data above, haven't yet showed signs of slowing materially on a seasonally-adjusted basis. Nor have auto sales, which represent another source of end-use demand and have been growing consistently YoY since May in China.
A swifter recovery in China relative to ex-China hasn't been reflected in high-grade imports, but has been seen in zinc ore imports, which are up over 30% YTD as of September. Treatment charges paid to smelters (for both imported and domestic ore) have however declined from high levels at the start of the year, with the most recent leg lower from around mid-September. Though there were supply disruptions at San Cristobal in Boliva and Alpayana in Peru, both have now resumed operations.
Lower TCs are likely at least in part driven by increasing smelter capacity therefore and whilst high-grade output is certainly increasing, YTD estimations are around 4.5% to October, suggesting ore stocks have likely built over the course of this year in China.
The ILZSG has ore production globally down 7.7% as of August, meaning China has increased apparent ore consumption notably at the same time as ore consumption overall has declined considerably. The reduction in the share of ore tonnage ex-China would be considered positive for LME market tightness were it not for the continued impact on construction demand ex-China.
The extent to which demand remains sluggish is evidenced from equipment manufacturers to construction PMIs to ex-China auto sales, which have only recently recovered to around last year's levels.
The ILZSG also have zinc production ex-China returning to last year's levels as of July however, implying supply of high-grade should have been more than sufficient recently.
China social stocks remain in and around levels seen in recent years, drawing excess stock built in 1H. LME stocks have however risen sharply, though remain relatively low in comparison with historical levels. Stocks have also increased from the LME's off-warrant reports, particularly in the US, and whilst total off-warrant material isn't published, there's no implication of material tightness ex-China from available data.
From a fundamental perspective therefore, LME prices appear to reflect an expectation of demand recovery beyond that which has already occurred.
Though convenient to lean on macroeconomic drivers and trends as the rationale for zinc's recovery, it makes the explanation of zinc's outperformance against peers at this stage of the recovery difficult to justify.