A role reversal for the ugly sisters

The commodities “supercycle”, it is now generally accepted, is over.
Slowdown in China, the lynchpin of the whole concept, is turning out to be a lot harder than anyone expected with industrial metal prices sliding across the board.

But for some of them the “supercycle” was arguably over many years ago.

Consider the example of lead and zinc, often called sister metals because they tend to be found in the same deposits and are as often as not mined in tandem.

Zincs “supercycle” price peak of $4,580 per tonne, basis three-month metal on the London Metal Exchange (LME), came in November 2006 while leads peak of $3,890 followed a year later in October 2007.

Neither made it back to those lofty heights in the Chinese infrastructure-fuelled boom that followed the Global Financial Crisis of 2008-2009.

And since then the two sisters have done little more than trudge sideways in well-worn ranges until joining in this years broader sell-off.

Such an uninspiring price performance has left the two being dubbed the ugly sisters, to be played off against each other in one of the LME Streets favourite relative-value plays.

That relative value trade has recently been turned on its head with lead re-establishing a premium over zinc for the first time since June of last year.

The premium itself is still small and tentative. As of Thursdays closing evaluations zinc ($1,687.50) was once again just out in front of lead ($1,649.00).

And the relationship looks set to remain confused and confusing since the turnaround has been driven by confused and confusing visible stock movements.

SMOKE…

In large part the collapsing zinc premium over lead has reflected collapsing sentiment towards the galvanising metal relative to its battery-dependent sister.

The new negativity has been caused by a rapid build in LME zinc stocks from 430,800 tonnes at the start of August to 617,325 tonnes in the middle of September.

That was thanks to the “arrival” of 228,225 tonnes of zinc at LME warehouses in New Orleans, long the black hole for surplus zinc stocks.

Suggestions that some of this metal may have been offloaded by Glencore as part of a broader debt-reduction strategy has reinforced the apparently bearish message that there is a lot of zinc inventory around.

But in truth these “arrivals” are almost certainly not “arrivals” at all but rather metal that was moved earlier this year to off-exchange storage now coming back into LME-registered sheds.

The zinc market is paying the collective price for taking at face value the steady drawdown in stocks in the first half of this year, driven by 286,500 tonnes of “departures” from New Orleans.

Sentiment, in other words, is being driven by what is largely storage arbitrage, irrespective of whose metal it is.

…AND MIRRORS

LME lead stocks, by contrast, seem to paint a more bullish picture. Over the same six-week period that zinc stocks ballooned lead stocks fell by around 50,000 tonnes and they are still sliding.

Moreover, the ratio of cancelled lead stocks, meaning those that are earmarked for load-out, stands at 25.6 percent. The ratio in LME zinc stocks is just 10.4 percent.

Alas, however, lead stock movements are no more “real” than those of zinc.

Rather, they denote nothing more than the latest skirmishing in the ongoing LME warehouse wars, the fight for inventory between different warehouse operators.

A mass raid on lead stocks earlier this year saw some relocated to South Korea and some to the Dutch port of Vlissingen with the apparent beneficiaries Metro and Worldwide Warehouse Solutions respectively.

But the games are far from over.

Of the 60,000 tonnes of lead that were warranted in July at the South Korean port of Busan, over half have been cancelled and delivered out again.

Vlissingen, meanwhile, saw a big cancellation of 21,000 tonnes of metal on Sept. 18, lifting that lead cancelled tonnage ratio.

When it comes to LME stocks, beware big round numbers. End-users tend not to use the LME system for such tonnages. Warehouse raiders, operating in alliance with major merchants, do.

Just who has raided whom in Vlissingen will only become clearer when the LME publishes its next monthly report showing a breakdown of stocks by operator.

But the key take-away here is that neither LME zinc nor lead stocks are saying anything particularly useful about underlying market conditions right now.

UGLY COMPETITION

That said, there is a case to be made for lead moving back to a sustainable premium to zinc, at least for a time.

Lead has a built-in immunity to broader macroeconomic cycles because so much of it is used in making batteries and so much of that battery usage goes to replace dead batteries.

Batteries fail in good times and bad times alike and they particularly fail during cold weather, meaning the Northern Hemisphere winter is often called the “battery kill” season.

That combination of defensive and seasonal strength helps explain why lead is currently the best performer among the LME contracts right now. Or, given the current bear environment, the least worst, down only 12.5 percent since the start of the year.

Its true that it doesnt benefit from the zinc narrative of imminent mine closures, a long-running story-line that is finally starting to take concrete shape as mining winds down at both Century in Australia and Lisheen in Ireland.

Both mines produce lead as a by-product but they are “lead light” relative to the amount of zinc they produce.

But this zinc narrative is a slow fuse affair. Although closing mines should over time feed through into a tightening market, the initial impact will be mitigated by stocks of both raw material concentrate and refined metal stocks.

And, as the market has just been reminded, there is a lot of zinc inventory sitting in New Orleans, whether it is visible or non-visible at any one time.

And a lot of lead inventory as well, which is why stock movements are characterised by sporadic raids by warehouse operators tussling over who gets to store it all.

The jury seems very much out on how the lead-zinc relative value trade is going to play out over the coming months with no clear consensus among analysts.

But remember. This is not a beauty contest. It is an ugly contest between two metals that experienced their “supercycle” price peaks almost a decade ago and have struggled to get anywhere close to those peaks since because of over-supply and legacy stocks.

Source: www.Reuters.com