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Zinc premiums set to rise: Macquarie

Keywords: Tags  SHG zinc, zinc premiums, Macquarie Capital Securities, Duncan Hobbs, LME, warehouse stocks, Andrea Hotter

CANCUN, Mexico — Zinc premiums look set to reach record levels in the next few months and could result in increased downside risk to London Metal Exchange tags, according to Macquarie Capital Securities Ltd. analyst Duncan Hobbs.

"We’ll see zinc premiums head towards 10 percent as a percentage of overall price in some locations," he said. "Rising premiums impact the breakeven price-cost calculations and may increase downside risk to exchange prices in a declining market since smelters can afford lower prices, if offset by higher premiums before cutting output."

The historic price-to-stock relationship has broken down and might not be restored for some time, Hobbs said.

"Zinc premiums and LME prices tend to trade together. But more recently the exchange price is flatter while premiums have continued to rise, creating a disconnect," he said.

Special-high-grade (SHG) zinc premiums in the United States are at 7.5 to 8.5 cents per pound ($165 to $187 per tonne), while those in Europe are at 5.9 to 6.4 cents per pound ($130 to $140 per tonne). The cash SHG zinc contract closed the LME’s official session at $2,084 per tonne Feb. 27, up 0.6 percent from $2,072 per tonne a day earlier but down 1.8 percent from $2,122 per tonne a week ago.

It has been the same for aluminum, Hobbs added, with the higher premiums making a considerable difference to the profitability of aluminum producers.

AMM’s Midwest P1020 aluminum premium is trading at 11.3 to 12 cents per pound compared with 8.1 to 8.6 cents at this time last year.

Rising premiums will also "reduce the efficacy of price risk management, as it becomes more difficult to manage the premium price risk," Hobbs said.

Markets can be "foggy" as premiums rise as a proportion of price, since premiums aren’t as transparent as LME prices.

"Producers may be more tightly bound to particular counterparties," Hobbs told attendees of the International Zinc Association conference in Cancun, Mexico.

Sharply rising zinc premiums might encourage miners to bring this into value-sharing calculations when negotiating treatment charges, he said.

Aluminum and zinc premiums have been driven by the "addressable market balance," or the amount of metal that is freely available to buy, Hobbs said.

Queues for getting metal out of LME-listed warehouses in certain locations have helped tighten availability of aluminum and, more recently, zinc.

"The LME is, in principle, intended to be a market of last resort for producers and consumers. But in practice, the LME has sometimes become a market of first resort for producers and of no resort for consumers," Hobbs said.

LME-registered warehouses in New Orleans account for about 90 percent of the zinc stock built up over the past few years, he noted.

But the bigger queues are currently elsewhere: the wait for getting metal out of LME-approved warehouses in Detroit is roughly 556 days, Hobbs estimated, while the average for aluminum from warehouses in Vlissingen, the Netherlands, is 696 days.

To address this issue, the LME has changed its rules to increase the amount of metal sitting in queues to be delivered out.

But access to dominant metal stocks in critical mass locations will remain problematic, Hobbs said.

"This rule change will make no difference to access to dominant metal stocks in critical mass locations, such as aluminum in Detroit and Vlissingen, and zinc in New Orleans, although it should increase access to other metals, including copper and lead," he added.

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