Zinc Bull Market
Scott Wright
Zeal LLC
November 3, 2006
The recent and infamous scourging
of the price of oil off its July highs has taken its toll on
the greater commodities markets. Commodities losses in this time
have left a bad taste in investors' mouths and have given fuel
to a vicious Wall Street campaign that touts the end of the commodities
bull market.
Oil has fallen around $20 per barrel in the last three months,
shaving over 25% of its value, and has taken other commodities
along for the ride. From the date of the oil high, gold had dropped
over $100 per ounce to its recent October low losing 16% itself
before a slight recovery in the last few weeks. And the stocks
of the oil and gold companies have also plunged in sympathy.
But through the fog of commodities hate lie the few exceptions
that have bucked the trend. While energy and precious metals
have taken a beating in recent months, base metals have remained
strong with several of them even eclipsing all-time highs.
Base metals are those industrial metals that have been so pivotal
in the massive build-out of the global economy led by Asia. And
as with the fundamentals driving the movement of energy and precious
metals prices, supply and demand imbalances have found their
way into the base metals realm.
There is a finite supply of base metals in the earth and the
process of extracting them is very capital intensive and time
consuming. So when growing demand for these metals outpaces supply
on a recurring basis, an economic imbalance creates itself. This
imbalance drives up prices until either demand shrinks or supply
is able to catch up with it, ultimately creating sustainable
surpluses.
In the last few years, even with year-over-year increases in
production on the mining front for all the base metals, suppliers
have not been able to keep pace with demand. And though this
imbalance is supposed to tighten in the coming years as the global
economy takes a breather, shortfalls are still expected.
Copper has
taken the limelight among the base metals as an investor favorite
and has held strong over the last few months hovering around
the $3.50 per pound level as global supply disruptions continue
to surface. And aluminum has been consolidating nicely following
its May spike that surpassed its previous all-time high in the
late 1980s.
After a bumpy ride the first half of this year, lead has had
an incredible run since June rocketing 81% higher and exceeding
its all-time nominal high just this month. And nickel has hardly
let up since June as it also continues to shatter its highs.
I recently penned an essay focused on nickel that highlights
the incredible fundamentals for this metal.
The next major base metal that I'd like to focus on is zinc.
Zinc just recently achieved a nominal all-time high and along
with its fellow base metals counterparts has bucked the commodities
trend in recent months. Zinc has had just an amazing run in its
own bull market. From its 2003 low of $0.34 per pound, zinc has
climbed an incredible 479% to a new all-time high of $1.95 per
pound just achieved a few days ago.
Even with this enormous gain, zinc's importance and future potential
is still relatively unknown to most investors. The largest and
most important application of zinc is its use in galvanizing
steel which protects the steel from corrosion. Zinc's galvanizing
effects have been measured to increase steel's life by a factor
of five.
Interestingly, according to a study that Battelle Laboratories
performed in 1995 updating a National Bureau of Standards study
in the 1970s, metallic corrosion costs the U.S. over $300 billion
per year, which is in excess of 4% of the GNP. While the average
person thinks of zinc as a primary vitamin supplement, in reality
its economic implications are staggering.
Other major uses for zinc include its utility in brass and bronze
among many alloys, die casting, batteries, chemical compounds
such as paint, ceramics and pharmaceuticals. Zinc's many different
applications rank it as the 4th most common metal in use behind
iron, aluminum and copper.
And most people do not realize that the U.S. penny is actually
made of copper-plated rolled zinc, which consists of 97.5% zinc
and only 2.5% copper. Pennies have been made in this fashion
since 1982, which was a good move by the mint since copper is
worth twice as much as zinc. And interestingly, even though the
penny is loaded with the cheaper of its two ingredients, with
today's commodities prices coupled with production expenses,
it costs about 30% more than face value to actually produce a
penny.
On top of its minting phenomenon, the fundamentals of zinc are
very strong to support its continued bull market. According to
the International Lead and Zinc
Study Group (ILZSG), global zinc consumption is expected
to rise by 3.9% this year and is estimated to rise by 2.6% in
2007. Even though total metal output is forecasted to increase
by 4.9% next year, a supply deficit is still expected by many
industry experts.
China is by far the world's largest zinc consumer as it accounts
for 30% of total global consumption, more than three times that
of the next closest country, the United States. And the ILZSG
expects China's zinc demand to increase by a massive 6.9% next
year, further exacerbating the global supply crunch.
As mentioned, zinc producers have increased their year-over-year
output to better supply the market. In fact, since 1995 the global
mined production of zinc has increased by 42%. But even with
this impressive increase, demand has outpaced the best the producers
have had to offer.
Another reason for zinc's sharp rise in the last couple years
revolves around its London Metal Exchange (LME) stock levels.
The LME is the largest non-ferrous metals exchange in the world.
And of its major functions to provide daily prices for the base
metals and provide the market for futures and traded-options
contracts, the physical storage of these traded contracts serves
an extremely important role.
Last month I wrote an essay that looked at the stock
levels and prices of each of the base metals to see how they
correlated. It makes sense that as global inventories of a metal
decrease, prices would rise as a result of the thin physical
supply. And the graphical depictions of this scenario revealed
incredible insight into the base metals run the last couple years.
As you can see in the chart
above, LME zinc stock has taken a dive this year. Over 280,000
metric tons of zinc have come off the top as consumers not being
fulfilled by the suppliers are pilfering the warehouses to satiate
their demand. Zinc stock has fallen by 73% so far in 2006 and
does not seem to be stabilizing as it continues knifing downwards.
Interestingly, as recent as May 2004, LME zinc stock tallied
770,000 metric tons. At today's levels this means global zinc
stock is down 86% in just over two years! At its
108,000 metric ton level today, warehoused zinc is only sufficient
to provide about four days of global consumption. These are alarmingly
low stock levels and they indeed provide legitimate justification
to the high zinc prices we are seeing today. Zinc fundamentals
weigh heavily on its price action as is apparent by this inverse
correlation of falling stock and rising price.
Back in May when gold and silver peaked, many of the base metals
including zinc exhibited sympathetic weakness as they began to
correct off of their interim highs. But when oil joined the party
and started tumbling from its July highs, the base metals shrugged
off the continued commodities weakness. While gold continued
to fall in sympathy with oil, zinc trended higher not only making
up its sympathetic gold losses but just recently achieving yet
another all-time high.
Zinc's bull market has been quite remarkable. After a long bear
market that forced zinc down to its 2002-2003 lows, it has caught
quite a bid. Base metals lagged behind the precious metals a
bit before they started their run, but as you can see represented
by zinc's magical four-year performance below, the global economy
has dictated a wild and exciting bull run for the base metals.
From the beginning of 2003,
the zinc market really started to tighten leading the way for
this metal to ride an orderly and textbook uptrend for nearly
three years. An environment conducive to rising prices was starting
to establish enough precedent to turn the heads of commodities
speculators. And when speculators finally started to see the
fundamental writing on the wall and could no longer downplay
Asia's economic impact on the natural resources front, zinc skyrocketed
in parabolic fashion.
This sharp rise worried many speculators, including myself, that
a swift and sharp correction would follow bringing zinc back
down below its 200dma and perhaps all the way down to its original
trend channel. But fortunately this has not happened. And this
comes as quite a surprise as parabolic price rises are nearly
always followed by sharp corrections in order to balance sentiment
and wipe euphoria from the floor.
But zinc, along with the rest of the base metals, is not ready
to give up its ghost quite yet. After zinc's parabola climaxed
in May, a mild correction indeed ensued. But as you can see in
the chart above, zinc has shown remarkable strength as it has
trended higher off its May top to eventually surpass the apex
in just a matter of months.
In addition to the simple economic fundamentals that have been
driving zinc's young bull market, future zinc-mining prospects
are bleak which should provide the bull continued longevity.
Just a few years ago, many of the major zinc mines around the
globe were barely breaking even with zinc prices in the $0.30
per pound range. The price of zinc was so low for so long that
miners had little incentive to put forth the massive capital
required to expand existing deposits and explore for new ones.
Though mining output has been on the rise, much of this can be
attributed to increases in same-mine output and the reopening
of previously decommissioned mines to take advantage of these
now high zinc prices. And even though some high-quality zinc
mines are coming online in the coming years, some of the more
mature primary zinc mines are living out the latter halves of
their lives. Many more zinc deposits will need to be discovered
and mines built in order to maintain and grow supply to meet
future demand. The evolution of a zinc mine takes significant
time and capital and continued high zinc prices are going to
be what allows this to happen.
As a speculator who understands zinc's fundamentals and is witnessing
its awe-inspiring price action, the opportunities that arise
from this have me chomping at the bit. This zinc and in general
base metals bull market has made futures traders betting in the
right direction barrels of money. But what is still not widely
known is that the average investor can take part in this powerful
bull by acquiring the stocks of the explorers and producers that
are charged with bringing these popular base metals to market
now and in the future.
With today's prices, most producing zinc mines that were able
to hang in there through the bear market are able to bring their
zinc to market at excellent margins. And the resilient zinc miners
that were making profits at $0.35 per pound zinc that are leveraged
to the price action of their underlying metal are able to score
incredible profits in today's environment.
But looking at the charts above, it's easy to wonder if zinc
is perhaps overbought and how much of a speculative premium is
built into today's price. I believe the markets can support the
current zinc price, but even if zinc temporarily corrects to
balance sentiment and gather itself up for another upleg, zinc
producers are still positioned to greatly profit. And with metals
prices currently hovering around record highs, producer companies
are continuing to yield record profits for their shareholders.
In the same fashion that gold and silver stocks caught their
bid as the precious metals took off, base metals stocks have
incredible potential going forward. But unlike gold and silver
stocks, most base metals stocks still exhibit obscenely low valuations
and are ripe for the picking. In fact, many base metals stocks
are still trading at bear-market multiples even today.
Even though many base metals stocks have enjoyed good initial
run-ups in this young bull market, they still lie in relatively
undiscovered territory for most investors and speculators. As
the word gets out that base metals stocks are still cheap, capital
should flood into them eventually driving their values to appropriate
bull market levels greatly rewarding those prudent ones that
were in the door first. With this in mind, we've been researching
base metals stocks all summer wading through the hundreds that
are out there on a quest to discover the best fundamental plays.
We have recently published another of our comprehensive research
reports that identifies our favorite 20 base metals stocks. These
research reports contain detailed fundamental discussions on
the individual stocks we believe have a high potential for success
in various sectors within the commodities bull market. Included
in this base metals stocks report are not only a handful of very
promising and undervalued zinc plays, but those companies that
focus on copper, nickel, lead and molybdenum among the many base
metals.
The stocks highlighted in this report range from small-cap junior
explorers to major producers. This inside look at our research
provides a sample of what we deem the best of the best base metals
stocks ultimately designed to support current and future base
metals stock trades for our newsletter
subscribers. If you are interested in getting an inside look
into our favorite base metals stocks, please purchase our
latest report today.
The bottom line is zinc is indeed one of today's hottest commodities.
As this metal's global imbalance works to correct itself, prices
should continue to stay high for many more years. With this,
the suppliers that are bringing zinc to market now and in the
future are positioned to achieve vast profits.
And investors and speculators wishing to take part in this excellent
bull market not only in zinc but in any of the base metals can
multiply their capital through the elite companies that discover
and extract the various metals from the earth. Base metals stocks
are still cheap, and a continued bull market in these metals
should drive them considerably higher.
Nov 3, 2006
Scott Wright
ZEAL
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what we are doing in terms of actual stock and options trading
based on all the lessons we have learned in our market research.
Please consider joining us each month at www.zealllc.com/subscribe.htm.
Thoughts, comments, or flames? Fire away at scottq@zealllc.com. Depending on the volume
of feedback I may not have time to respond personally, but I will
read all messages. Thanks!
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