Commodities | Feb 16 2012
– Zinc TCs may settle at better than expected levels
– Platinum forecast to move to a premium to gold
– China the key for silver prices
– US steel output in an up-trend
– Cheap gas a positive for steel, iron ore
By Chris Shaw
The end of this week will see the International Zinc Association conference, this year to be held in Palm Springs in California. Macquarie notes this conference is important for the industry, as usually this is where zinc miners and smelters settle annual treatment charges (TCs), which are the fees miners pay smelters to process raw materials into zinc metal.
TCs have been in structural decline for a number of years and for some time it had been expected this trend would continue in 2012. But Macquarie sees the negotiation process as more finely balanced at present, with scope for smelters to outperform previous expectations of further declines even if a significant increase is something of a stretch.
There are four main components to TCs – a base treatment charge, a basis zinc price, an escalator for each US dollar rise in the London Metals Exchange zinc price above the basis price and a de-escalator if zinc prices fall.
The structural decline in TCs has seen revenues shift from smelters as pricing power has moved upstream towards miners, this trend developing as China has become a progressively larger buyer of imported concentrate.
In the current negotiations Macquarie notes leading zinc miners have opened negotiations at around US$170 per dry metric tonne, basis US$2,000 per tonne zinc. This would be a fall of around US$40 per dry metric tonne from the 2011 benchmark and is well below the smelter opening proposal of an increase of around US$50 per dry metric tonne.
If the current spot market discount of more than US$150 per dry metric tonne to realised TCs on benchmark terms was simply reset to the differential at the start of last year it would imply a reduction in the base TC this year of US$50 per dry metric tonne.
But as Macquarie notes, this would be a greater reduction than miners have reportedly sought, suggesting the miners don't see current spot prices as a fair reflection of where the benchmark terms should be settled.
As well, Macquarie suggests at least part of the fall in spot TCs is due to Shanghai Futures Exchange zinc prices trading at a premium to LME prices since last September, as such an environment means Chinese smelters may be willing to concede lower spot TCs than would otherwise be the case.
A supportive factor for the smelters' case is Chinese zinc output has surprised to the upside in recent months. At the same time Chinese smelter metal output has flat-lined recently, something Macquarie suggests is because TCs have not been high enough for the smelters to make money. This has meant not all materials potentially available have been purchased.
If Chinese output continues to surprise to the upside Macquarie suggests there is unlikely to be any shortage of either zinc concentrates or the metal itself. This means miners are likely to continue pressing for further reductions in price participation, something Macquarie suggests could see the pricing of zinc concentrates follow the lead of copper and lead where most material is now priced on flat terms where there is no smelter price participation.
Overall, Macquarie suggests there is sufficient zinc concentrates supply at present, making a reasonable outcome one where prices roll over on terms within a few dollars of last year's benchmark at equivalent zinc prices. This implies a base TC of US$205-$215 per dry metric tonne, an outcome Macquarie suggests would be better than consensus expectations from just a few months ago.
In the precious metals market, RBS notes a recent rally in platinum prices has been driven by ongoing strike action in the sector. The rally has been enough for the metal's discount to gold to contract to around US$64 per ounce, down from more than US$220 per ounce a month ago.
Medium-term RBS expects this trend will continue, to the point gold will move to a discount against platinum by the final quarter of this year. The discount could be as much as US$50 per ounce over that quarter on RBS's numbers.
Two key areas driving silver demand have been industrial applications and investment demand and Standard Bank expects the latter of these will likely remain in place through 2012. But for prices to push higher there must also be strong fabrication demand and here the bank suggests the outlook is less clear.
Standard Bank's forecasts call for fabrication demand growth of 3% this year, driven largely by the electronics and photovoltaic sectors. Emerging markets, China and Japan should be behind much of the fabrication demand growth.
For China specifically Standard Bank expects fabrication demand growth of 7.5%, against an expected 7% increase in Chinese mine supply. This should create a supply gap of around 1,440 million tonnes this year.
As Standard Bank notes, much of the silver market tightness of recent years is the result of China moving from a net exporter to a net importer of silver. From 2008 to 2011 China has imported 7,319 million tonnes of the metal.
To fill fabrication requirements China could either import additional metal or draw down existing stockpiles and Standard Bank suggests the latter is occurring at present. This implies as long as China doesn't import significant amounts of silver, the price is unlikely to rally on any sort of sustainable basis.
But if stock levels deplete and China is forced to re-stock, Standard Bank suggests silver could push above US$35 per ounce and trade towards the US$40 per ounce level. The bank sees this as possible closer to the third quarter of this year.
In the steel market, Commonwealth Bank notes weekly US steel output data continues to show a steady up-trend. Capacity utilisation is now in the high 70% range and total output is close to 100 million tonnes per year in annual terms.
CBA points out the steady improvement in US steel output is following recent improvement in US economic data. As an example, better labour market outcomes have translated to higher vehicle production run rates.
The key for CBA will be how much current economic momentum continues and can translate to a pick-up in construction and manufacturing activity. The latter is currently being boosted by a weak US dollar and an associated acceleration in export activity.
In energy, Macquarie takes the view cheap gas could provide opportunities in the Direct Reduced Iron ((DRI)) space as DRI has become more of a staple feedstock for steelmakers in recent years. Cheaper gas prices improve the economics for additional DRI use, while Macquarie also sees scope for benefits for iron ore producers from a future linkage to scrap.
This is because DRI is essentially a substitute for ferrous scrap usually used in electric arc furnace steel production. For the past 20 years DRI output has grown at around 10% per annum and total output now stands at more than 80 million tonnes per year.
US output has not grown in step with this, but Macquarie suggests the structural change in US gas prices to lower levels could see a step up in US DRI output. One difficultly in increasing DRI output is the need for a consistent source of high quality iron ore, but current economics are making such a change far more compelling in Macquarie's view.
This is because while production costs for DRI have fallen scrap prices remain high, so the potential conversion margin for DRI output in the US is now its highest since 2008. The margin is also at its biggest discount to prevailing scrap prices.
Assuming some upside potential for DRI, the iron ore market could also benefit due to the DRI pellet market. These pellets are a raw material for DRI. Historically DRI pellets have attracted a 7.5-10% premium over standard pellets given lower impurities, but linking them to blast furnace pre-material is inefficient in Macquarie's view.
These pellets could be relatively easily linked to the scrap/DRI price, something Macquarie suggests would generate a premium for DRI pellet to blast furnace pellet prices of around 10% this year. This supports Macquarie's view this could be the next change in iron ore pricing, as miners with high quality ore attempt to maximise returns for their product.
