October 17th was an unusual day for the zinc market and zinc prices. After prices hit the highest level in ten years in October, Zinc LME prices closed down 3.4% (October 17) to $3,085 a tonne.
2016 was one of zinc’s best years in recent history, rising to over $2,500 a tonne from a low of $1,500 a tonne in late 2015. Global infrastructure projects and increased demand from rebounding economies in the United States and growing populations in Asia and India drove this increase. The thinking early in the year was that the demand for zinc was not going to stop.
In an interview in August, Margaux Resources (TSXV:MRL) CEO Tyler Rice stated, “China’s economic growth proved stronger in the first half of the year than expected. If infrastructure investment activity carries on this way, we should see it continuing to support the price of zinc, and I can see our beginning-of-the-year predictions proving to be lower than year-end prices.”
With the prospect of long-term demand for zinc high, we have seen the impacts this has had on the huge growth in zinc prices.
However, despite these optimistic projections, today’s decrease marked the largest one day drop in Zinc prices in the last six months. That has some people worried and examining what is driving today’s decline.
What Caused Drop in Zinc Prices on October 17th?
In short: Rising Inventory Levels. As Canadian investors, we are fully aware that metal prices move up and down depending on supply and demand. The “trick” is making sure we understand the why in order to make decisions on how to play the market in the coming days and weeks.
With respect to zinc, there are a couple of things that caused today’s drop in price. The first issue causing trouble for zinc prices is on-warrant inventories.
On-warrant inventories are the stockpiles of zinc that are sitting in warehouses and have not been purchased by buyers. In other words, it is unclaimed inventory that is laying idle waiting for demand. The value of this on-warrant inventory jumped to 17,850 tonnes, which is an increase of over 27% in October. It is easy to see why we would see zinc prices drop with this rising inventory.
If you want to continue to keep track of these inventory levels, you can check out the warehouse level page at KITCO. Here is what we are seeing with respect to these zinc levels. It is clear to see that since early October Zinc inventories has been on a pretty sharp increase.
When asked about rising Zinc inventories, Commerzbank analyst Daniel Briesemann was reported as saying that, “I think higher production should be on the cards in the short term because quite a few mining producers have flagged that they are going to increase output.”
Increased output does not help in an environment where zinc stockpiles are going up. Added output only manages to increase supply while demand is steady, which is further context to why investors punished zinc prices today.
U.S. Dollar Impacts Zinc
The second reason for the fall in price was the strengthening U.S. dollar. A strong U.S. dollar puts pressure on all commodities as it becomes more expensive for buyers using other currencies. In Canada this is especially important as we can get hit with rising inventories which lowers prices. However, it can also help us when our dollar gets stronger in relation to the U.S. greenback. Unfortunately, today the strengthening U.S. dollar went against us.
Regardless, with the current strengthening of the U.S. dollar compared to other global currencies, the impact is that zinc prices have been negatively affected. Drivers of this rise in the U.S. dollar were industrial production and capacity utilization that was showing a positive trend as well as import-price data helping the U.S. economy.
Projections for the U.S. dollar are not helping the go forward picture for zinc prices either. Analysts are focusing on NAFTA discussions between the U.S., Mexico, and Canada. Although not great for Canada, the NAFTA discussions seem to be having a positive impact on the U.S. dollar which could continue as those conversations progress between the countries.
Zinc Market | Go Forward Thinking
One day does not make a downward trend so it is important to not over react to today’s drop. Yes, it was the largest drop we have seen in awhile, however there are still some strong fundamentals that can help the market going forward.
As previously written about on this site, “China and the developing world are gobbling up zinc as they execute on multi-staged infrastructure projects that require many tons of galvanized steel.” Those projects do not stop quickly, and it appears that China’s growth does not look to be slowing down.
According to Reuters only a few months ago,
“The International Monetary Fund on Wednesday raised its forecast for China’s 2017 economic growth to 6.7 percent, its third increase this year, citing ‘policy support, especially expansionary credit and public investment’”.
Final Thoughts on Zinc Market
Growth in the zinc market has strong potential to continue once again. Established demand will continue to drive a zinc supply deficit which should start to push zinc prices back up. Rather, when new mines come online and deficits turn to surpluses the current dynamic will change.
As a result, it will take some patience for Canadian zinc investors. Even with last week’s drop due to rising inventories and a strong U.S. dollar, the fundamentals and strong infrastructure growth in developing countries should continue to support strong zinc prices. We were way ahead of this trend, writing Zinc Mines Are Closing Down – Good News for Zinc Stocks in 2012. More recently, in May of this year we outlined zinc’s renewable energy potential. Click here to read This Metal Could Crush Fossil Fuels.
