Column: Warning bells sound at London Metal Exchange zinc market

Traders work on the floor of the London Metal Exchange, in London, Britain, September 27, 2018. REUTERS/Simon Dawson

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LONDON, April 11 (Reuters) – Will zinc be the next nickel?

Even as the London Metal Exchange (LME) tries to put the pieces back together from its broken nickel contract, there are signs that zinc could be the next metal market to crash.

A raid on LME zinc stocks has seen available tonnage fall to two-year lows. Traders are taking advantage of the market of last resort to ship metal to Europe, where smelting capacity has been idled by high energy prices.

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The effect is to tighten LME time spreads and keep the absolute price rising. The latest trading at $4,320 per three-month LME tonne of metal sits just below a potential options black hole.

There is a strong sense of deja-vu with both the LME copper market, which had to be restricted last October, and the nickel contract, which had to be suspended in March.

LME Stocks, Prices and Time Frames

PERFECT BULLS STORM

Nearly 60,000 tonnes of LME zinc stocks have been written off in preparation for physical offloading since the beginning of the month. Singapore was raided to the tune of 40,000 tons with the remainder divided between Baltimore and New Orleans.

Total LME stocks look healthy at 123,675 tonnes, but the amount of zinc available for physical contract settlement has plummeted to 45,925 tonnes, the lowest since February 2020.

The bourse’s European warehouses hold a measly 500 tonnes, all in the Spanish port of Bilbao, demonstrating the pressure on Europe’s physical supply chain caused by the loss of regional foundry output. read more

Zinc premiums in Europe are at record highs and rising, according to Fastmarkets, which just raised its assessment of northern Europe by another $10 to $440-500 a tonne above the LME cash price.

It is no surprise that Trafigura, which operates three European zinc smelters, and others are tapping into the market of last resort to close the supply gap, sources have said. Trafigura has declined to comment. read more

US premiums are also at record levels, reflecting increased competition with Europe for available units and lower-than-expected production at the Valleyfield smelter in Quebec.

Noranda Income Fund, which owns the plant, has cut its 2022 production forecast by 15,000 tonnes to reflect operational problems in the first quarter of the year. read more

LME stocks in the US have also been almost liquidated with only 550 tonnes available in New Orleans.

This is a perfect bullish storm for the zinc market and analysts have raised their price expectations accordingly.

Fitch, for example, raised its average forecast for 2022 from $2,900 to $3,500 per tonne, citing the prospect of a deeper supply shortfall of 172,000 tonnes this year after an estimated shortfall of 48,000 tonnes in 2021.

TURBULENCE AHEAD?

The depletion of freely available LME stocks has inevitably narrowed time spreads, the cash premium flexed to $85 in early April and was valued at a still-wide $55.50 at Friday’s close.

The LME imposed retracement limits on all of its physical delivery contracts in early March, capping the potential cost of rolling over a position overnight to 1% of the previous day’s closing price.

There is also a 15% cap on cross contracts on daily price movements, which in the case of zinc translates to a potential change of $638 per tonne.

That is highly relevant given the potential for price volatility ahead.

LME traders have been nervously watching the buildup of open interest in May and June call options with strike prices extending as high as $5,000 a tonne.

Compared to Friday’s closing prices, total bullish volumes amount to 88,000t and 93,000t in May and June, respectively.

Those outstanding call options create a vacuum above the market. If the price accelerates towards them, sellers will be forced to hedge their exposure by buying the underlying futures, creating a vicious upward cycle.

The risk of a meltdown similar to the one that briefly pushed nickel above $100,000 a tonne before the LME suspended the market is clearly present in zinc given the low tonnage available in the storage system.

CLOSE MONITORING

The LME is not responsible for cracks opening up in the global physical supply chain for zinc.

But it is on high alert for potential market turbulence after events in the nickel contract, which is still in critical condition as low liquidity prevents reconciliation of large short positions accumulated by China’s Tsingshan Group. read more

The LME told Reuters that “we note the current tightness in the zinc market and are closely monitoring all metals to ensure market activity remains orderly.”

That’s the standard exchange response to any sign of trouble.

However, given the bullish trend in the zinc contract, the LME’s compliance department’s monitoring will have to be anything but standard.

The exchange cannot risk another dime.

Andy Home is a columnist for Reuters. The opinions expressed are yours.

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Edited by Barbara Lewis

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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which, according to the Trust Principles, is committed to integrity, independence and freedom from bias.

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