Zinc — Acute Supply Reductions Have And Will Support Prices Higher

Zinc prices began 2016 at $0.70/lb and rose steadily through the year, reaching a year-to-date high of $1.32/lb in early-December. Zinc’s rise was a supply story through and through (Chart 4), in an industry that hasn’t seemed able to reduce production despite a persistent low-price environment (see: nickel, aluminium). First came the natural declines, with the depletion-prompted closure of the Century (Australia) and Lisheen (Ireland) mines taking 500 kt of zinc concentrate — the raw resource that is later refined into metal — off the market. However, these mines had been winding down for a while, and zinc had still found itself dragged down with the rest of the base metals complex through to the beginning of 2016.

Glencore’s decision to economically idle another 500 kt of supply brought the market further into deficit, and, after breaking free of the base metal malaise, prices were able to rise from $0.73/lb at the beginning of the year to $1.32/lb by November (+81%). The decision to idle some of Glencore’s mine supply came before the zinc rally began in earnest, but it took time for the bearish base metals narrative to ease enough for the market to refocus on zinc’s acute supply challenges. The pace of these gains has been greater than anticipated, and the increasing net-length of speculative positioning leaves zinc particularly vulnerable to changes in sentiment. We expect the supply deficit to catch up with current bullish investor positioning, with prices forecast to average $1.25/lb in 2017 before declining inventories prompt a second rally into the $1.50-1.60/lb range in 2018.

Chart 4

Copper: Despite Its Recent Rally, Copper Remains Weighed Down By Supply

Copper has experienced an interesting year. The red metal spent the first nine months of 2016 meandering between $2.00-2.30/lb and looked like a sure bet for worst performer before a surprise rally lifted prices by nearly 30% year-to-date to $2.70/lb by early December. The earlier malaise rested on a “wall of supply” narrative, in which significant volumes of new mine output were expected to come to market over the next two years and continue to swamp middling demand growth. Copper mine disruptions, which typically run 5% of total supply in an average year, were also low in the first half of 2016 (1-2% range). Copper’s rally followed news that mine disruptions spiked in the third quarter (though were still running low) and Chinese demand came in slightly stronger than forecast. This view of tighter copper balances was further supported by a lower-than anticipated early TCRC contract settlement, which typically indicates tight concentrate supplies. The fundamentals-driven bump pushed copper out of its former range, which attached significant speculative attention, further stoking prices (Chart 7).

Despite recent optimism witnessed in the elevated price of copper, we continue to believe that fundamentals point to further surplus supply, and prices have already begun to recede. 2017 could see marginally tighter balances given numerous supply risks (labour contracts, Indonesian export regulations), but these are likely to be minor issues. However, some of the aforementioned “wall of supply” probably made it to market sooner than anticipated due to relatively smooth project ramp-ups, meaning that some of the supply expected to weigh on prices next year could have arrived in 1H16. Prices are expected to end the year around $2.50/lb and trend lower, but our prior annual average forecasts of $2.20/lb will likely be upgraded slightly in January.

Chart 7 and 8

Source: Scotiabank Commodity Price Index, December 20, 2016.