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COLUMN-No relief for zinc shorts as London squeeze rolls on: Andy Home

Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

* LME Zinc Price, Spreads and Stocks: https://tmsnrt.rs/2Ic7Oef

LONDON, May 30 (Reuters) - The London zinc market is in the grip of the most protracted and acute squeeze in 30 years.

On the London Metal Exchange (LME), the benchmark spread -- the difference between the cash price and that for three-month delivery <CMZN0-3> -- flexed as wide as $161 per tonne this week before closing on Wednesday at $149.

If you want a historic precedent, you'll have to go back as far as 1989.

A flash squeeze in 1997 saw the cash-to-threes spread hit $263 but it was over in a matter of weeks. Only the rolling tightness of the late 1980s bears any comparison to current market dynamics.

Then, as now, the core issue was low stocks in the LME warehousing system. Inventory was less than 1,000 tonnes at one stage in 1988, although it was a very different market back then. The LME had just introduced its SHG zinc contract and the exchange's warehouse network was largely concentrated in Western Europe.

Now there are LME warehouses in multiple locations in both Asia and the United States and while current headline zinc stocks are higher than in 1988 at 100,850 tonnes, they are desperately low relative to the size of today's market.

The extended play-out of a multi-year supply-chain squeeze is still defying expectations of imminent resolution.

DESPERATELY SEEKING METAL

LME zinc stocks have recovered from their early April low of 50,425 tonnes but most of the metal warranted in April and May turned up at just two locations - Rotterdam and Vlissingen in the Netherlands.

New Orleans, which had seen regular inflows as metal rotated between on- and off-LME storage, has been quiet bar a burst of deliveries totalling just over 6,000 tonnes at the start of April.

What's noteworthy is that deposits of zinc into the LME storage system have largely dried up over the last couple of weeks, even as the rising cash premium increases the incentive to deliver.

Indeed, LME stocks have started falling again, keeping the pressure on time-spreads.

CHINESE IMPORTS STILL BOOMING

Physical zinc availability is being tested and, so far, has been found wanting, at least in part because metal is still moving from the international to the Chinese market-place.

China's imports of refined zinc hit 77,600 tonnes in April, the highest so far this year.

Cumulative imports of 219,000 tonnes in the first four months of 2019 were up 27% on last year, when, it is worth remembering, a record 715,000 tonnes entered China.

But it is still hard to discern any sign of stock build within China. Zinc stocks registered with the Shanghai Futures Exchange (ShFE) rose to a 12-month high of 124,000 tonnes over the Lunar New Year holiday before falling steadily to just 56,320 tonnes last Friday.

In Shanghai, as in London, the forward zinc curve is heavily backwardated with nearby dates commanding a premium over forward ones.

The Chinese market, in other words, is showing every sign of being as short of zinc as the rest of the world.

BOTTLE-NECK

That's significant because everyone's looking to China to resolve the market tightness.

The current phase of the zinc market cycle is defined by a surge in mine supply as producers react to the price rally that peaked in February last year at $3,595.50 per tonne.

Better availability of mine concentrates should translate into better availability of refined zinc as high conversion fees give smelters an incentive to lift run-rates.

Since China is the single biggest hub of global smelter capacity, it should be leading the way, but the transmission mechanism doesn't appear to be working efficiently judging by China's continued absorption of units from the rest of the world.

Its refined metal output continues to lag last year's run-rates, although the gap closed to just 0.4% in April.

The surge in mine supply seems to be stuck behind a smelter bottle-neck caused by environmental constraints on many Chinese plants, including smaller ones which fall below the market's collective radar.

The broader disconnect is captured in the latest monthly figures released by the International Lead and Zinc Study Group (ILZSG), which show global mine output rising by 1.8% but refined metal output falling by 3.0% in the first quarter of this year.

GAME OVER?

The rolling zinc squeeze has upended expectations of a speedy collapse in both spreads and outright prices but there remains a strong consensus that the market will start to loosen up as the year progresses.

The problem is that zinc has been defying expectations for many months. Those trying to capture the shift to surplus by shorting the metal are now paying the painful spreads price.

Those still tempted to go short should pay close attention to China's strong imports and the conspicuous lack of fresh deliveries into LME warehouses.

All the available evidence suggests that the supply of refined metal is still struggling to match demand, with ILZSG estimating a global supply shortfall of 15,000 tonnes in the first quarter of 2019.

LME spreads are transmitting the same message, even as the outright price weakens under the weight of macroeconomic negativity.

The game, in other words, is not yet up and it won't be until the market sees tangible evidence that the zinc market is genuinely transitioning from supply deficit to surplus.

(Editing by Kirsten Donovan)