Stirring in the zinc pot

Higher demand and lower supply should eventually galvanise the zinc price.

Summary: Zinc has been range trading for some time, but there are increasing expectations it could soon break out. The global stockpile of the base metal is shrinking, and so is mine production. But there’s no shortage of demand.
Key take-out: Locally listed zinc stocks could become pocket rockets if the zinc price takes off.
Key beneficiaries: General investors. Category: Commodities.

Christmas is coming, and so too is a big change in the world zinc market.

However, for Australian investors keen to take a ride on the rust-proofing metal, it might be a case of taking on board extra risk in the form of a punt on small speculative zinc stocks, or looking overseas for reasonable exposure to a metal which can deliver spectacular returns.

In the last zinc boom, which ran from 2004 to 2007, the price of the metal rocketed up by almost 300% from as low as US38 cents a pound to $US1.50/lb.

Back then Australia had a much larger pool of zinc-exposed stocks, which is hardly a surprise, as the metal is part of the country’s mining history. It is the third ingredient in the cocktail which led to the birth of Broken Hill: silver, lead and zinc.

Geologically, the three metals often occur together, which can cause marketing problems should one enjoy greater demand than the others, because miners have to produce all three whether all three are commercially viable or not.

The best example of what a zinc boom can do to a stock with exposure can be seen in the rocket-ride of Perilya, a company which inherited a large part of the old-workings around Broken Hill after the companies conceived there (such as BHP, CRA, BH South and North BH) had moved on to more profitable ventures.

For much of 2004 and 2005 Perilya traded at around 75c. When the zinc price took off, so did Perilya. It peaked at $4.93 in early 2007, before crashing back, like all boom-time stocks, to 12c. Control eventually passed to a Chinese mining house, which is in the process of mopping up minority shareholdings.

The disappearance of Perilya means that today there are only a handful of locally listed zinc-exposed stocks, such as Terramin (TZN), Iron Bark (IBG), YTC (YTC) and KBL (KBL). All are small, and only Terramin is producing worthwhile amounts of zinc.

The coating on zinc’s recovery

More on ASX-specific stocks later. First, a look at why interest in one of the world’s most important industrial metals (you can’t galvanise steel without it) is stirring and might be in the early stages of a strong price recovery.

While no-one is yet saying that zinc might will repeat its three glorious years, which ended in 2007, the metal’s cheer squad, led by a man with more exposure to zinc than anyone else in the world, reckons it is poised to outperform.

Ivan Glasenberg, chief executive of the world’s fourth-biggest miner, Glencore Xstrata, has been tipping zinc as a big revival story for more than a year.

His interest in zinc is two-fold. Firstly, because 13% of Glencore Xstrata’s first-half profits this year came from zinc, second only to copper, making his company the only big miner with a significant exposure to the metal. Secondly, because he has a deep understanding of the zinc market as a commodities trader and miner.

Putting the personal interest to one side, it is worth looking at a few zinc facts and what the experts are saying about the metal.

On the London Metal Exchange (LME), the most important market for industrial metals, the zinc price has been trading between the tramlines of roughly US80c/lb and US$87c/lb for much of the year, with a hint of an upward trend since June.

More interestingly, the stockpile of surplus zinc held in the warehouses of the LME has been in decline for the past 12 months, sliding from 1.23 million tonnes to around 991,000 tonnes. See Stockpile will keep lid on zinc’s cream.

The stockpile seems highly unlikely to rise in the foreseeable future because demand is reasonable, but production is poised to plunge as a number of the world’s biggest zinc mines run out of ore and close.

Mine closures ahead

In Australia, the biggest closure will be of the Century mine owned by Chinese-based company MMG, which is scheduled to reach its use-by date in about two years, joining the big Brunswick mine in Canada, which closed in May.

Earlier this month, the chief executive of MMG, Andrew Michelmore, rated zinc a better recovery story than copper because “over-supply is shrinking sharply” and an annual surplus that has dogged the zinc market for several years could turn into an annual deficit.

“My view would be that when the numbers come out, I wouldn’t be surprised if there was no surplus at the end of the year for 2013,” he said. “So, in 2014, you’re going to start seeing it getting tighter.”

Some big investment banks agree. Last week, Morgan Stanley told clients that the “zinc cycle is shifting faster than expected”.

The bank said that zinc has one of the best fundamental outlooks among LME traded metals, together with its sister metal, lead.

“We forecast both markets (zinc and lead) to record sizeable market deficits in 2014,” Morgan Stanley said.

Despite its optimism, the bank is not forecasting a spectacular rise in the zinc price, but does see a steady increase stretching out to the year 2018 when the price should be around $US1.05/lb.

Morgan Stanley relies, in part, on a zinc research paper from the British consultancy, Wood Mackenzie, which forecasts the closure of 134 zinc mines worldwide between now and 2030 as ore reserves expire. Over the same time, only 26 new mines are likely to start production, a number which will expand if the zinc price does rise sharply.

The challenge for Australian investors is finding a way into the zinc market without taking on the extra risk of buying a small stock with speculative characteristics, or to hunt out a global zinc player such as Swiss-based Nyrstar (which owns zinc smelters in Tasmania and South Australia), or London-listed Glencore Xstrata, which has worldwide zinc interests.

The share price of Terramin, which operates the small but profitable Angas zinc mine near Adelaide and is exploring overseas, has been rising steadily over the past year, from a low of 1.3c to recent trade at 4.1c. This gives it a market value of $33 million.

Iron Bark and YTC are the other two locally-listed zinc stocks of potential interest because both have attracted the financial backing of Glencore Xstrata, which is keen to source zinc for its metal trading operations.

Iron Bark, which the Perth stockbroking firm Hartleys described, somewhat ambitiously, as “the next zinc rocket” in a May research report, is planning to develop the big Citronen orebody in the frozen wastes of northern Greenland. YTC is developing the Hera-Nymagee deposit near Cobar in western NSW.

Over the past year Iron Bark’s shares have risen from 3.9c to 5.2c ,with the latest price capitalising the stock at $20 million – and a long way short of Hartley’s May price tip of 19c.

YTC is up from 14.5c to 22.5c, for a market value of $60 million.

For investors with a high-risk tolerance Terramin, Iron Bark and YTC represent local zinc entry points, but all three need a higher zinc price to succeed.

Better, at this stage, to wait and see if the supply-squeeze theory implicit in the mine-closures argument is valid, with the key tests being when/if the price rises back over the US90c/lb mark, and whether the LME stockpile continues to fall.