The unloved metal comes around

PORTFOLIO POINT: A supply shortfall in the zinc market could be about to send the price up. Here's how to get set.

No one loves zinc. It is an over-produced metal with a low price and a reputation for destroying the companies that operate zinc mines. But, in terms of a future turnaround story, evidence is growing that a zinc rebound could be on the way.

For investors with an interest in bottom fishing among some of Australia’s true penny dreadfuls, a high-risk (high-reward) opportunity is evolving where it is possible to see the chance for a double-your-money punt on heavily discounted zinc stocks.

Definitely not for widows and orphans, the emerging zinc play is based on predictions that the closure of big mines – including the biggest of them all, the Century mine run by Minmetals in Queensland – will tip an oversupplied zinc market into undersupply in the next two to three years.

Losing Century’s 500,000 tonnes of zinc a year, and 200,000 tonnes from the ageing Brunswick mine of Xstrata in Canada, has the potential to flip 300,000 tonnes of annual excess zinc production into a 400,000 tonne shortfall.

It is the potential for a supply squeeze, more than demand drive, that has added to the belief that zinc is due for a revival, with the next overproduction glut potentially being delayed by the global banking crisis that is limiting the flow of funds necessary to develop new mines.

First hints that zinc was stirring came last year and were reported here (see Zinc, for the big or the brave). Back then it was noted how Glencore, the world’s biggest commodity trader, was placing big bets on zinc, partly because it can make money in several ways, either through refining charges, or as a miner in its own right.

The downward movement in the zinc price after the Glencore deals were reported did nothing to boost confidence in the metal. From about $US1 a pound, the zinc price fell to less than US80¢. Zinc is currently trading at US95.6¢, but most local zinc stocks, including Kagara (KZL), Perilya (PEM), Terramin (TZN), Ironbark (IBG), and Blackthorn (BTR) remain in the sin bin.

Of those stocks, only a few are worth adding to an investment watch list. They are:

• Ironbark, which has a world-class zinc project in Greenland (of all places), but also has the world’s biggest zinc refiner, Swiss-based Nyrstar, as a major shareholder, and Swiss-based commodity trader, Glencore as a financial backer. On the ASX, Ironbark has risen from 20¢ to 26¢ over the past month, but remains capitalised at less than $100 million.
• Blackthorn, another Australian zinc play heavily influenced by Glencore, which has taken a direct investment position in Blackthorn’s Perkoa project in Africa. Over the past month, Blackthorn has risen from 51¢ to 57¢, mainly on the strength of encouraging copper exploration results.
• Perilya has also risen sharply, from 32¢ to 42¢, since the start of the year, and while it is Australia’s biggest pure zinc play thanks to its historic mines in Broken Hill, its share register is Chinese dominated.
• Kagara is a significant zinc producer at its Mt Garnet mines in north Queensland, but has diversified into copper and nickel, and damaged its reputation by spending heavily on an ultra-deep zinc deposit, Admiral Bay, in northwest WA. Admiral Bay is currently for sale. On the market, Kagara is up from 29¢ to 35¢.

But, the reason for dusting off your files on those stocks is that the future supply-shortfall thesis (and lack of bank funding for new mines) that Glencore started acting on last year is being picked up by other close observers of commodity markets.

Three times over the past three months different commodity experts have noted the change in the zinc market and potential shortfall in production, which could drive the price sharply higher.

The views of London-based CRU (Commodity Research Unit), the US investment bank Goldman Sachs and a comment from the chief executive of Nyrstar, that he wants the firm to invest more heavily in mining, lessening its exposure to refining, add to the view that the zinc equation is changing.

Roland Junck, who moved to Nyrstar after overseeing the creation of the world’s biggest steel-making business by merging Mittal Steel and Arcelor, told the Bloomberg wire service two weeks ago that he had planned to spend €2 billion buying mines.

Junck’s target is to have Nyrstar earning half of its profits from mining by 2016, easing the company’s reliance on processing the metal at sites such as Port Pirie and Hobart, assets that passed to Nyrstar after the collapse of Zinifex, which followed the collapse of Pasminco – two failures which ought to tell you a lot about the risks associated with zinc.

CRU’s view of zinc was delivered in a paper at the Mines & Money conference in London late last year. Two graphs used by the commodity forecasting firm’s Peter Ghilchick caught the eye of zinc watchers.

The first showed how China was a net importer of zinc (as well as being a major producer), with a consumption-and-production profile similar to copper and nickel, the inference being that China will remain a major buyer of zinc.

The second was CRU’s “temperature chart” of mineral demand, showing those minerals that are hot (in demand and with the price rising) and cold (low demand and flat price). Today, the hot minerals, according to CRU, are molybdenum, gold, potash and manganese. Zinc is 15th on a list of 24 commodities, in a sector marked “cool”.

In the next two-to-three years everything changes for zinc, with CRU lifting it to the top of its list and ranking it as the hottest mineral in the 2014-to-2015 period. Only one other mineral is forecast to enjoy a faster upward ride, lead, which is often mined in association with zinc. Lead, CRU reckons, will rise from 22nd place on today’s temperature chart to fourth in 2014-15.

The Goldman Sachs view of zinc comes via its inclusion in a list of commodities to watch in the medium term. In its pre-Christmas equity strategy note to clients, Goldman included zinc “assuming current nervousness on Europe’s sovereign debt issues and China’s Credit tightening dissipates”.

Equivocal as the Goldman view is, the fact that the world’s least-loved metal made it to a list of commodities to watch is a significant improvement.