The go-to junior for a tightening zinc market
There has been a solid but quiet performer in the commodities sector recently. Flying largely under most investors' radar is zinc, up 3.9% in 2014. It's often overlooked because as an "industrial" metal it doesn't have the same shine as "precious" metals. According to many analysts, zinc is setting up nicely to continue its upward run in value, and at today's levels offers an interesting option for savvy investors to enjoy potentially substantial returns.
The zinc market demand is currently between 13-14 million tonnes a year, with projected growth of 5% a year. Roughly half of all zinc is used for protecting steel from corrosion (galvanizing). It's an overlooked but important end use: industry experts estimate that if steel was left unprotected it would cost an industrial country's economy at least 4% of GDP each year.
About 17% of zinc demand comes from zinc-based alloys that support the die casting industry. From bathroom fixtures and door and window hardware to office equipment and tools as well as automotive and countless electronic components, zinc castings are everywhere.
Zinc Price
The market is already in a supply-demand deficit and has been for the last couple of years. Stockpiles are rapidly declining. In 2014, zinc output lagged consumption by 296,000 tons, according to the International Lead and Zinc Study Group.
Scotiabank commodities analyst Patricia Mohr has a price forecast of $1.60 per pound for zinc in 2016 as the deficit increases. That's 72% higher than today's price of $0.93 cents per pound and could have investors scrambling for zinc names.
Zinc stockpiles have already been cut in half in the last year and currently sit at ~458,000 metric tonnes.
Upcoming zinc mine closures will certainly hasten the decline in stockpiles. Of particular importance will be the closure of MMG's Century Mine in Australia, which is winding down at the end of June. In 2014, Century supplied 465,696 tonnes into a market size of 12 million tonnes (3.8% of world supply).
Later this year, Vedanta Resources' Lisheen mine in Ireland will also close, removing ~150 thousand tonnes from the market.
Don Lindsay, CEO of Teck Resources, one of the world's largest zinc producers, recently stated, "It's starting to look like 2006 all over again." He's referring to a powerful move that took place with the zinc price that year. Stockpiles went from the 600,000-tonne level to below the 100,000 -tonne level briefly before rising again during the financial crisis. Zinc was up 51.6% in 2005 and 125.7% in 2006. It may be setting up for a similar price move in the near future.
Pipeline
Zinc exploration and development companies must fill the pipeline for future zinc demand. But there are only a handful of quality zinc development projects in the world, which could very easily lead to takeovers in the space at significant premiums – especially for higher-quality names. (Note: most zinc development companies have issues, be they metallurgical, permitting, capex or grade.)
In 2011, with zinc down 25%, Nyrstar Resources saw an opportunity and decided to go shopping. Nyrstar understood that the fundamentals for zinc were setting up favourably so the company purchased two Canadian-listed zinc companies: Breakwater Resources and Farallon Mining. Breakwater was taken over for $663 million in cash (a 44% premium) while Farallon was purchased for $443 million in cash (a 23% premium). Nyrstar may have jumped the gun a little but zinc has had three straight years in the green since the acquisitions.
With the aforementioned two takeovers, Nystar essentially cleaned out the primary zinc producers on the TSX, leaving only Trevali Mining (TV:TSX) as the pure production play.
John MacKenzie, Anglo American's former head of copper, is planning to launch his own public vehicle soon – and is eyeing zinc. He is reviewing takeover targets ahead of a planned $300m to $700m mining float later this year.
"Because zinc has been so unfavoured there's been very limited development, particularly by the majors, so there's relatively little high-quality supply coming online," MacKenzie told Global Mining Observer.
Next down the food chain for investors are the zinc development companies.
Canada Zinc Metals (CZX:TSXV)
Canada Zinc Metals is one investment option for those looking into the zinc space. Here are four reasons why investors might want to consider CZX:
- Primary commodity (zinc) has strong fundamentals for a price rise.
- Strong management with a proven track record of success.
- A high-quality project with expansion potential.
- A solid balance sheet with no need to raise money anytime soon.
Let's delve a little deeper into these factors:
Supply Crunch
The fundamentals for the zinc price look extremely strong in the next 6-24 months. Large zinc mines are beginning to close down and it's likely we will see the deficit in the zinc market begin to grow. No new large mines are in the pipeline to replace those coming offline.
Source: Wood Mackenzie 4Q'13 and MMG Analysis
Demand is expected to remain strong at 5% growth per year for the next couple of years, underpinned by continued growth in the Chinese steel sector and a trend towards value added steels.
If these forecasts hold true, the market will need to somehow find the production equivalent to what the Century mine put out last year (465,696 tonnes) just to keep up with demand.
Glencore, a large zinc producer, stated at its recent AGM "An additional 3-3.5Mt of zinc supply (is) needed over the next 5 years to balance the market."
China, the world's largest zinc producer, is still a wildcard in the zinc market but many analysts do not believe that the Chinese can increase production enough to replace the mines coming offline. China is very secretive when it comes to publicizing production numbers of commodities. What we do know is that China wants to reduce its pollution issues, but to what extent this effort slows down mining is anyone's guess.
Economics 101 holds that when demand exceeds supply the price of whatever is in demand will rise. The zinc market has been in deficit for the last couple of years. Stockpiles have been rapidly declining and are half of what they were last year. Zinc has had a 16% move in the last 3 years but many analysts believe that is just the beginning.
Zinc's last major supply/demand deficit occurred in 2004 with zinc quadrupling in 2 years (going from $0.50 to $2).
(Image source CRU Group)
