Zinc: Strong Fundamentals, Equity Options
Zinc demand is rising. Demand rose 2.7% in 2016 and is expected to rise 3.8% this year and 3.7% next year.
Meanwhile, refined zinc production (i.e. metal coming from smelters) fell 0.4% last year while mine production dropped 6.7%. A few mine startups and restarts this year and next should allow for positive growth in refined zinc over the next few years, but growth will be modest and is susceptible to challenges, like lower-than-expected Chinese mine production growth.
All told, it means a market in deficit for the next four years. The deficit means stockpiles will continue to get drawn down. When stockpiles sink below critical levels, the price reliably responds.
That critical level is usually six week of global consumption. Global inventories held 8.1 weeks of global consumption at the end of 2016, down from 9.3 weeks at the end of 2015. In the chart, you can see how the price surged in 2005 when inventories drop below critical levels.
Most zinc analysts have similar predictions to those shown above, in a chart borrowed from RBC Capital Markets (Zinc Metal Outlook – First Quarter 2017). As you can see, inventories fall below critical levels next year. Prices are already surging in response, but even after zinc gained 78% last year most analysts still see room for further gains, to take zinc likely above the US$1.50-per-lb. level.
The biggest risk to this zinc story is China, both from the supply and demand sides. On the supply side, China supplied 35% of zinc contained in concentrate in 2015 and slightly more than that in 2016. Chinese mine production is expected to grow 7% or more for the next two years, but it could be even more if the government puts economic opportunity (mines producing into a strong zinc price) ahead of the environmental protections that have been forcing small mines to close.
On the demand side, China is by far the world’s most important zinc consumer, eating up 46% of the metal and generating 105% of demand growth in the last decade. Most zinc analysts acknowledge that Chinese growth is the biggest risk to their zinc demand forecasts. In the RBC report, for example, the analysts assume Chinese Industrial Production (IP) growth of 5.6% in 2017, which would generate 6.1% increase in Chinese zinc requirements and thus a 3.8% global demand increase. However, they calculate that an actual IP increase of only 4.6% would reduce the global demand increase to 3.3%.
Lots of numbers. The point is, China is by far the biggest player in zinc and, at the same time, is the hardest to predict, both in terms of supply and demand. The Chinese government seems intent on enforcing the environmental regulations that are forcing many small mines to close; Chinese growth appears to be picking up. As long as these factors remain generally correct, the zinc deficit argument will remain valid, but both factors deserve a watchful eye.
I also want to note that zinc markets do not usually live very long. You saw in that first chart how short the 2005 zinc bull market was; it lasted only two years, really. The chart below captures that again, while also showing Treatment Charges (TC’s).
TC’s are what smelters charge to process zinc concentrates. The specific amount applied to a particular concentrate depends on grade and deleterious elements, but the averages shown on the chart indicate how desperate smelters are for feed. When concentrates are hard to come by, TC’s fall. And Spot TC’s usually fall ahead of the price spike, as you can see happened in 2005.
Looking at the right end of the chart, the same pattern is setting up right now. Treatment charges have fallen off dramatically in the last year. The zinc price has gained, but the rise is likely not done.
Zinc equities also usually lag the zinc price, for two reasons. First, it takes time for the market to believe that zinc is making a real move. Looking again at the chart above, you can see that the price perks up every five years or so, but then usually settles back. The move needs to show it is more than a little lump before investors get on board.
Second, investor interest is a bit limited because there just aren’t that many equity options. When gold goes on a run, there are hundreds of investment options, from major producers to tiny explorers, from indexes to ETFs to physical metal. With zinc there are perhaps a dozen stocks that provide direct exposure to zinc, and ten of them are high-risk explorers or developers (I’m guess-timating here). There is only one focused zinc producer – Trevali Mining (TSX: TV) – on the Toronto Exchange. Teck Resources (TSX: TCK.B) also offers good zinc exposure, but you have to also be willing to take on coal, copper, and oil.
With the zinc bull now fully established, the sector is expanding. I know several groups setting up new zinc deals; I know even more companies actively seeking zinc assets (most with little success). Established zinc equities have already moved way up – Trevali and Vendetta Mining (TSXV: VTT) are both triples versus a year ago, for example – so getting good leverage to the market now requires finding a company that hasn’t made those moves yet.
The stock I bought last week was the result of my search for exactly that: a promising zinc stock that hasn't yet seen a price jump. To learn more, sign up at www.resourcemaven.ca/subscribe
Besides your far superior record, your format is the best I’ve seen in PM newsletters. It’s so easy to go back for older info on companies when appraising my portfolio. This compliment is from someone who has hired about a dozen letter writers so it has perspective. Keep up the good work.
Gwen, you are truly a beacon of sound thinking and honest insight in a market sector full of charlatans.