London 27/07/2016 - Market participants see a turning point for zinc in the fourth quarter as a long-awaited arbitrage opportunity between the London Metal Exchange (LME) and the Shanghai Futures Exchange (SHFE) could arise then prompting imports into the Chinese market.
The arbitrage window between the London and Shanghai markets had opened shortly in January this year but remained closed thereafter.
The impact of the closed arb has been reflected in rising zinc stocks levels in Shanghai's bonded zone - inventories were at their lowest at end-January at 60,000-75,000 tonnes, and have since risen to 113,000-127,000 tonnes at end-June, according to FastMarkets' monthly survey of multiple warehouse companies.
Total imports for zinc concentrates have also dropped 29.5 percent year-on-year to around 1 million tonnes in the first half of this year, according to China’s customs data.
But China will still need to import both zinc concentrates and refined metals in the coming months even though domestic mines have increased due to higher prices, said a smelter source.
"China cannot be self-sufficient for zinc. Smelters will have to either cut production or import at a loss,” he said.
The three-month zinc price on the LME hit a 14-month high of $2,294.5 per tonne on July 21, up almost 60 percent when prices bottomed out at a six-year low of $1,444 on January 12. It closed at $2,175 on Thursday.
Still, many see the upside momentum of the LME zinc price as limited as it has not been supported by fundamentals due to the huge off-warrant stock overhang across the world.
“Prices would go even higher in the short-term due to investment demand but it will reach a point when there is no more room to creep up as refined stocks have not been dropped as quickly to support prices. The timing is more likely to be in the fourth quarter,” said a Shanghai-based trader.
A price around $2,100-2,300 on the LME would be the main trading range for the rest of this year should Glencore continue to stick to most of its production cuts and in the absence of major macro-influences such as another US interest rate hike, market participants said.
“With the current macro factor stabilising, and low likelihood for another Fed interest rate hike in September, zinc would be on the top priority for funds if they want to choose a metal to invest in. And that is why prices have been stable above $2,000,” said an industry source.
In the Chinese market, local zinc smelters are seeing tighter concentrate supply in the domestic market even as they shun away from overseas raw materials due to the closed arbitrage - losses are around 1,337 yuan per tonne if smelters import concentrates, according to FastMarkets' calculation.
“The arbitrage ratio between SHFE and LME is currently still below 8. It had increased from 7.9 to 8.5 at some point last year, which explains the high volume of concentrate imports going into China,” said another Chinese zinc smelter source.
SHFE zinc prices would trek higher if demand picks up in the fourth quarter as consumption of refined zinc stocks translates into better fundamentals in the domestic market, sources said.
SHFE zinc prices have been in an upward trajectory recently as funds favour its fundamentals. The SHFE September zinc contract closed at 16,950 yuan per tonne on Thursday, down 65 yuan from the previous day's close.
But the industry source also noted some uncertainty for prices in the fourth quarter. "The macro side could come into play in the fourth quarter in the form of another Fed hike in December and also Glencore could resume production. Then we would see zinc prices come under pressure," he said.
(Editing by Vivian Teo)