Zinc Remains Structurally Bullish

by: Joshua Hall
Summary

I review my process for analyzing the fundamentals of the zinc market.

Mine supply will likely return to surplus next year, however, the real issue is smelter capacity.

Investments in new smelter capacity will need to be made over the next several years or exchange inventories will run out.

I see the zinc market as structurally bullish through 2022.

Note: the following article is an excerpt from a report that was originally published on April 11, 2019, for Industrial Minefinder™ subscribers.

My Process for Analyzing Zinc Fundamentals

I want to start this article by taking some paragraphs to explain how I come up with my fundamental outlook on zinc.

I take what I would say is a structural approach to analyzing the zinc market. I really do not pay attention to monthly exchange inventory changes or short-term price changes. My strategy is to understand whether the zinc price has a structural tailwind or headwind and what a reasonable long-term price estimate should be.

To implement this approach on the supply side, I track the production of every single zinc mine of significant size where the information is publicly available. I also track mines under development or mines that may be developed within several years. In practice, this means that I can track every large mine except some in China, but I also have good sources for overall Chinese production to bridge the gap. My database of roughly 67 mines covers about half of the world's production. The other half that I do not track comes mostly from China, other small mines around the world, or by-product production. I essentially track all the big mines that are going to move the supply side of the market. I like spending hours reviewing the production of all these major mines because it produces insights into the strength of supply and gives me a real "feel" for the potential of mine supply. For example, I would say that 90% of the zinc mines that I follow produced less in 2018 than anticipated.

Zinc mines produce zinc concentrates and not the finished product, so I also look at the amount of refined zinc production. It is the difference between refined zinc production and demand that influences exchange inventories. When demand is exceeding refined production, then exchange inventories (and other off-exchange industrial inventories) have to be drawn down to make up the difference. This is what has been happening in recent years.

I tend to focus on mine supply versus demand to form my structural analysis of the market. Deficits tend to push inventories down and surpluses tend to push inventories up. This is important to follow because the zinc price tends to be inversely correlated with inventories. When there is a mine supply deficit, inventories will deplete and push the zinc price higher. This relationship can be seen in the following chart:

Source: Teck investor presentation

Before we dig into the fundamentals, it is also important to note that I do not make any assumptions for mine setbacks. If a significant source of zinc mine supply or smelter capacity goes offline, then this would magnify any bullish case that I make for the metal.

A Structural Deficit Remains

The following table pulls the relevant data together to show where we are now and where I think we are headed:

in million tonnes 2017 2018 2019 2020 2021 2022
Mine Supply 13.1 13.2 14.1 15.2 15.8 16.3
Refined Zinc Production 13.9 14.2 14.7 15.2 15.2 15.2
Demand 14.3 14.5 14.8 15.1 15.4 15.7
Exchange Inventory Change -.4 -.3 -.1 +.1 -.2 -.5
Year Ending Exchange Inventories .5 .2 .1 .2 .04 ???
Refined Production vs. Capacity 87% 89% 92% 95% 95% 95%
Mine Supply vs. Demand(negative = supply deficit) -1.2 -1.3 -.7 +.1 +.4 +.6

Assuming 2% annual demand growth from now until 2022, I see zinc mine supply versus demand remaining in a deep deficit this year of 656,000 tonnes before swinging to a slight surplus next year of 77,000 tonnes. Thereafter, I see a steady surplus of mine supply over demand. However, there is more to this story...

The critical issue facing the zinc market is smelter capacity. According to Wood Mackenzie, global smelter capacity is 16 million tonnes. Right now global smelters are running at about 92% capacity. They will have to maintain this pace and increase it as we move closer to 2020 or exchange stocks will be exhausted. This is where the rubber meets the road. Zinc smelters are simply going to have to run all out. The price of zinc is set to keep rising to spur the needed expansions of smelter capacity. This looks like a story that is just now heating up and set to play out over the next couple of years. I estimate that global smelter capacity will have to increase by 5% to 10% over the next several years.

Overall, I see the zinc market remaining structurally in a bullish posture until this smelter capacity is added and China reaches the end of its current economic cycle which I think still has about 3 years to run.

Here is a weekly (logarithmic) price chart of zinc:weekly price chart of zinc chart courtesy of barchart.com

Zinc currently sits at $2,700 per tonne ($1.22 per lb.) after pulling back from $3,000 per tonne ($1.36 per lb.) earlier this year. I see it continuing to move up this weekly price channel over the next 18 months with the potential for a run to $4,000 per tonne ($1.81) if the negative trade cloud over the market dissipates. The zinc bull market is still in force.

Strategic Conclusion

Zinc mine supply is increasing but this is not the whole story. A lack of global smelter capacity is why zinc inventories have continued to decline. I see them remaining under pressure until new zinc smelter capacity comes online. Because of this, I remain structurally bullish on zinc for the next several years.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I'm an investment advisor and owner of True Vine Investments, a Registered Investment Advisor in the State of Pennsylvania (U.S.A.). I screen electronic communications from prospective clients in other states to ensure that I do not communicate directly with any prospect in another state where I have not met the registration requirements or do not have an applicable exemption. Any investment advice or recommendations involving securities referenced in this article is general in nature and geared towards a readership of sophisticated investors. This article does not involve an attempt to effect transactions in a specific security nor constitute specific investment advice to any particular individual. It does not take into account the specific financial situation, investment objectives, or particular needs of any specific person who may read this article. Individual investors are encouraged to independently evaluate specific investments and consult a licensed professional before making any investment decisions. All data presented by the author is regarded as factual; however, its accuracy is not guaranteed. Investors are encouraged to conduct their own comprehensive analysis. Positive comments made regarding this article should not be construed by readers to be an endorsement of my abilities to act as an investment advisor.