Growing Chinese Zinc Inventories Not Reflecting Fundamentals

By James Wellstead – Exclusive to Zinc Investing News

A recent series of articles form Financial Times Alphaville reporter Izabella Kaminska have highlighted the commonplace practice of using zinc and variety of base metal and commodity (most notably copper) inventories as a collateral in finding liquidity for a variety of investment opportunities. Known as ‘inventory financing,’ firms in China are taking advantage of the delayed payment function in letters of credit to “…buy a commodity [copper in the example described by Kaminska] on credit, take delivery of said copper, sell said copper at full price to market, then post the returns in higher yielding assets until the due date for the full payment of the letter of credit arrives — in most cases some 180 days later.”

The same practice is also potentially being pursued with zinc stocks, with China’s inventories reportedly as high as 1.5 million tonnes and still seeing increased imports in the first quarter of 2011. The task, however, is to tease apart how much of this increasing stock is driven by demand, and how much is driven by those seeking its arbitrage value. The different uses can have impacts not only on the actions of investors and producers, but potentially Chinese regulators as well.

With construction accounting for half of galvanized steel demand, and galvanized steel accounting for 56 percent of zinc demand, Reuters columnist Andy Home has said the only logical explanation for this increasing stock is the leveraging of zinc futures on the Shanghai Futures Exchange for ‘financial arbitrage.’ While the practice is perfectly legal in China, the potential impact this may have on zinc prices is not fully clear.

Analyst Stuart Burns of Metal Miner recently said that “Rising stocks, softening demand and continued strong production, at least in the short term, suggest prices are set to ease further this year.” However, with the expected closure of major mines between 2012 and 2015, and an expected recovery in the western housing market suggests that “the market could be better balanced from 2012/13 into the future. In the meantime, there is not much to support current prices and we would not be surprised to see them continue to drift lower.”

Zinc was up 0.8 percent at $2,278 a ton on spot markets yesterday. Three-month delivery of zinc on the London Metal Exchange (MLW) recently traded at $2,235 a ton, for a drop of 8.9 percent in 2011, as the metal remains the worst performing of the six main metals traded on the LME.

Company News

Trevali Mining (TSX:TV) has recently signed a provisional agreement to expand its Peruvian mine, Santander, with a $30 million term loan from German financial service provider WestLB. The Santander mine, which operated in conjunction with Glencore International A.G., is the second project Trevali expects to produce 2,000-tonne-per-day zinc-lead-silver production expected by the end of 2011. Trevali also owns Canadian operations, with Halfmile and Stratmat polymetallic deposits located in New Brunswick, and the Rattan copper-zinc deposit in northern Manitoba. The Halfmile operations are also expected to produce 2,000-tonne-per-day.

Nyrstar (EBR:NYR), the world’s biggest producer of zinc, said that the damage from the fire that struck its plant in Belgium is still unknown. However, Chief Operating Officer Greg McMillan said in a conference call “I don’t envisage there will be any major or material impact to production. If it’s a few thousand tonnes, we will catch that up over the balance of the year.”

Nyrstar also recently released a management report noting that zinc concentrate had increased by 64 percent in Q1 of 2011 from Q4 and also noted that its financial performance benefited from a 3 percent increase over the previous quarter in the average price of zinc, partially offset by a 1 percent average decline in the dollar against the euro in which its operating costs are denominated.