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Wood Mackenzie reports 2019 zinc outlook

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Global Mining Review,

2018 was a tumultuous year for zinc, with the price falling from a high of over US$3600/t early in the year to under US$2300/t at one point. Support from improving fundamentals in the form of declining metal stocks was undermined by negative sentiment generated by the trade spats between the US and most of its major trading partners. If as forecast, zinc's fundamentals can reassert their influence on price movements, 2019 is set to be another tumultuous year, with the price projected to revisit its 2018 highs.

Smelter performance is critical to market outlook

For the second consecutive year, the most critical issue facing the zinc market is the performance of zinc smelters and Chinese zinc smelters in particular.

In 2018, the revenues and profits of China's smelting industry came under pressure on several fronts. In the first half of the year, the tightness of the concentrate market resulted in imported spot treatment charges falling to very low levels. With revenues from the zinc price also falling and failing to compensate for low treatment charges, many smelters chose not to buy imported, expensive and unprofitable concentrate and instead cut utilisation rates and production.

The difficulties facing Chinese smelters were exacerbated by increased scrutiny from China's environmental agencies. The widespread crackdown forced many smelters to curtail production and in some cases to close, in order to comply with various environmental restrictions on solid, gaseous and waste water emissions.

This combination of poor profitability and difficulties in complying with environmental regulations resulted in Chinese smelter production falling to its lowest level since 2013.

In 2019, a modest surplus in the concentrate market, a recovery in the zinc price and China's smelters making the necessary investments to become environmentally compliant is forecast to result in Chinese refined production rebounding. However, it remains to be sustain whether the sector can sustain the strong performance achieved in November 2018.

It is not just Chinese smelters that have been under pressure. Low treatment charge revenues and low prices have weighed heavily on Nyrstar, the world's second largest producer of refined zinc. As a consequence, questions have been raised about its ability to service its debt in 2019. While, speculation about a potential restructuring and asset sales has grown.

With Chinese smelters facing environmental constraints and rest of world smelters already operating at elevated utilisation rates, the risks to the robust forecast growth in smelter production are on the downside in 2019.

Mine supply set to grow

In 2018, the shift from a deficit to surplus concentrate market was driven by the combination of a modest rise in mine supply coinciding with a contraction in smelter output. In 2019, however, a substantive rise in mine supply will outstrip the growth in refined production and is forecast to result in a concentrate surplus and the replenishment of previously depleted stocks of concentrate.

The large net increase in mine production is, excepting six large mines, made up of typically modest increases in tonnage terms at a large number of mines. However, for many of these the increases represent a significant uplift in annual output and the rise in output may not proceed as smoothly as owners would like.

In addition to the typical technical difficulties in expanding output, a number of operations also face issues in terms of the nature of the zinc concentrates they produce. Of the six largest expansions (increasing by 70 000 tpy or more), four produce less desirable concentrates.

These issues can be overcome by smelters blending with other concentrate to reduce the levels of deleterious elements. This, however, will increase the sales costs for miners in spreading their concentrates across a larger population of smelters. Which has implications for increased working capital requirements, which together with high TCs, could exert pressure on the finances of some mines.

Although not an issue for 2019, by 2020 inventories of concentrate are forecast to become excessive. This has the potential to exacerbate the situation for miners as the financing of stocks of unsold concentrate could become problematic.

Macro economics and sentiment

Wood Mackenzie’s base case assumption is that although smelter production, and Chinese smelter production in particular, will enjoy robust growth in 2019, the concentrate market will see a substantial surplus. Nevertheless, and despite very modest forecast consumption growth the refined market will see a significant deficit which will result in global stocks of metal falling to exceedingly low levels and stocks in exchange warehouses virtually eliminated. This will provide fundamental support to the price and driving a recovery to levels last seen in February 2018.

As was the case in 2018, however, macro-economic concerns and investor sentiment can readily override fundamentals. While it is certain that the Chinese authorities will continue to step up their efforts to ensure the health of the Chinese economy, their interventions will be more nuanced than in the past. It is likely that economic data in 1Q19 and into 2Q19 will remain weak which will ensure that investors in commodity markets remain cautious during 1H19, as evidence of the success of the Chinese authorities will be slow to appear.

What is far from certain is how the trade-war and the wider geo-political rivalry with the US will evolve. The most recent developments point to an easing of trade tensions and if the two sides reach a compromise this could provide a trigger for a boost in investor sentiment towards riskier assets such as commodities. Against a backdrop of a fundamentally tight zinc metal market this could fuel a surge in the price to levels in excess of the peaks seen in 2018. But if the trade war heats up again and another round of tariffs and other measures ensue, investor appetite for commodities and other riskier assets would be further dampened and it is possible that the zinc price could languish around current levels despite a tighter metal market.

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