FOCUS: Zinc bear trap snaps on stockholders, premiums as backwardation widens

Over-eager zinc bears have contributed to a ballooning backwardation in London Metal Exchange price spreads, having bet prices would drop further and sooner than fundamentals have allowed.

The LME cash/three-month zinc price spread swung into a $43 per tonne backwardation on Monday June 18, from $30 per tonne backwardation on June 12 and a $3 per tonne contango at the end of May.
The spreads have since come in to a $32 per tonne backwardation as of Tuesday, but barring a market squeeze from September 2017 to February this year, the market has not priced the three-month price this much lower than cash since the financial crash of 2007.
The phenomenon, which is pressuring spot zinc ingot premiums lower in Europe and Shanghai, is partially a result of market shorts covering heavily against bearish bets on the metal, which has been on a stratospheric rise since 2016, culminating in reaching 11-year highs of $3,595 per tonne in February.
“Zinc was the underperformer this year and the market generally went short,” Bank of America Merrill Lynch metals strategist Michael Widmer said.
LME stocks have been steadily rising since February, last at 246,175 tonnes; just 7,800 of that are canceled.
“I think there was a lot of complacency because of the amount of warrants freely floated,” ING analyst Oliver Nugent said, referring to zinc available to borrow on the LME.
“We’re still short 200,000 tonnes of units so it’s perfectly natural that we could have a big cancelation in the meantime,” he said.
Shanghai bonded stocks vulnerable
A build-up of stock in the Shanghai bonded zone has also contributed to short covering, sources said.
Metal Bulletin assessed zinc stocks in the bonded zone at 207,000-209,000 tonnes on June 2, down marginally from a peak of 215,000-225,000 tonnes in May. Bonded stocks are up by 32% year to date.
The higher the stock of unmoving zinc, the more LME positions need to be rolled on a monthly basis.
“The market was ripe to be squeezed, just like last year when it happened. There is no demand and everyone has cargo in Shanghai,” a zinc trader in Asia said.
Premiums under pressure
This week, premiums for zinc ingots cif Shanghai dropped to a one-year low of $110-120 per tonne. Premiums globally are under pressure.
Traders annually bring zinc metal to bonded warehouses in Shanghai and wait until an arbitrage opens to lock in risk-free profits by importing metal.
At several points across 2017, the arbitrage opened to the tune of over $100 per tonne, sending in-warehouse Shanghai premiums as high as $200 per tonne in August.
But this year’s only open Shanghai import arbitrage in May-June yielded only marginal gains on premiums at the time, and premiums for metal could drop further if traders decide to unwind physical positions there.
“The backwardation costs a dollar a day, plus rent, plus financing, so stockholding is expensive nowadays,” a second trader said. “It’s a tough market to trade.”

Archie Hunter

archie.hunter@fastmarkets.com

Published

Archie Hunter

June 20, 2018

17:44 GMT

London