About a frog, a broken conveyor belt and some old zinc discoveries

Tipping points or inflection points are curious phenomena to those inhabiting a linear world. The familiar anecdote of the frog in cold water is part of this linear world where he gets boiled alive if you very gently heat the water so that the rise in temperature is so gradual that the little amphibian does not notice. This is a metaphor for the inability or unwillingness of people to react to significant changes that occur gradually, such as climate change.  If the frog hops it is a tipping point and part of the world of quantum physics and now he is on dry land and inhabits a very different place or energy level.

Historically the zinc price is closely correlated with zinc stocks and in the past a tipping point has been three weeks of zinc metal consumption remaining in the various bonded zinc warehouses around the globe. I have no idea why that might be the case – it is sumply empirical. We are currently at four and a half weeks and falling rapidly. There was a deficit in the zinc market last year of 250,000 tonnes and that shortfall must be covered from the LME, SHFE and Chinese warehouses.

If demand is growing for a metal then, unless there are some shenanigans going on, a decrease in supply will make the price go up. This is exactly what is going on in the zinc market and that is why it is a supply-side story. If you want to understand the dynamics of the zinc market then you need to listen to Glencore and drink from a unique pool of knowledge.

Glencore predicts 3.7 percent year-on-year growth in demand for zinc over the coming five years and that equates to between 3 million to 3.5 million tonnes of additional zinc we will have to find when the recent closure of its Perseverance and Brunswick mines are followed by MMG’s Century in Australia toward the end of the year and Vedanta’s Lisheen in Ireland sometime soon.   It is also why Glencore is spending almost $1 billion on ramping up production in Australia in the Mt Isa mining camp at a cost of $245 million and commissioning Lady Loretta at a capital cost of $350 million and expanding production in the first half of this year at McArthur River (HYC Mine) at a cost of $369 million. The original Mt Isa mine which christened the cluster of mines in the region was discovered in 1923, Lady Loretta was discovered in 1969 and McArthur River was discovered in the 1950s but the latter because of challenging metallurgy was only commissioned in 1995. McArthur River is also called the HYC Mine which stands for “had your chance” apparently in memory of the young company geologist who asked his boss if his new discovery could be called after him – I guess not.

So Ivan Glasenberg the CEO of Glencore, a man who is highly sensitive to supply-side discipline, is backing his team’s view on a lucrative opportunity surrounding a significant tightening in the zinc market over the coming years by making a billion dollar bet.

Glencore is pushing its global zinc production from 1.4 million tonnes of contained zinc in concentrates to 1.6 million tonnes and about 50 per cent of this increase will come from its three pillars of production in Australia. This triptych of Australian zinc mines is indeed a cluster of Tier 1 mines by any yardstick and defined as a large, expandable, long life (>20 years) mine with favourable mineralogy and geographic location and in the lower half of the cost curve. Glencore is effectively sweating these mine assets in Australia with resources to support 42 years of mine life and that is the impressive part but there must be concern for sustainability of this part of the business which is reliant on fleshing out discoveries made over forty years ago – so much for a free flowing pipeline.

Glencore reckons that an additional 3 to 3.5 million tonnes of zinc supply is needed over the next five years to balance the market based on consumption growth of 3.7 percent y-o-y. The breakdown is 2.7 million tonnes to 3 million tonnes from increasing demand and mine closures make up the balance – the closure of Century and Lisheen will remove 600,000 tonnes and the delay in the opening of MIM’s Dugald River mine by a year will block another 1.5 percent of global mine supply from 2015’s total. 

Over the next five years a total of about 6.4Mt of zinc concentrate is needed. Given that the average declining grade of ore in an underground zinc mine is around eight percent this means that we need additional production of about 12 million tonnes of ore over the next five years.

Effectively we need to dig up a Lisheen Mine every year to cover the additional supply needed in the global zinc market. The Lisheen Mine in Ireland is nearing the end of its life and was discovered in 1990. Mine development started in 1997 but the mine did not produce until September 1999, some nine years later with a resource base of 23 million tonnes averaging 12% zinc and 2% lead. In a mining friendly country it took almost ten years to delineate a resource, complete a feasibility to define a reserve, define project economics and then permit and build a mining. Finding and building new zinc mines seems to be on a much slower track compared to our healthy growing global appetite for the metal. With virtually no grassroots exploration being financed and increasing lead times to permit new mines, even in mining friendly jurisdictions, it looks like the rest-of-the-world outside China is stuffed if we are relying on it to meet increasing global demand for zinc.

Zinc is a primary product. Recycling accounts for only 5 to 10 percent. So 90 to 95 percent of this new zinc has to come from new mines or expansions. Glencore would not expect significant substitution even if the price of zinc was to double and that substitution would only be for niche applications. The bulk of zinc consumption is for galvanizing steel so construction and car manufacturing are the main drivers of demand. Although there is risk of deflation in Europe there is a critical need for investment in crumbling infrastructure on the continent. Closer to home in Ireland year-on-year car sales are up 30 percent.

Ultimately a sustained zinc price will need to be at an incentive level high enough to stimulate talented explorers and attract investors with the risk appetite for the big reward. But as we can see in the case of Lisheen it takes a long time for the conveyor belt with zinc ore to start feeding the hungry mills once an economic discovery has been made.

So why should we listen to Glencore – See my April 9th, 2014 post “Zinc mine supply – have we run out of time?”.

In zinc particularly Glencore has a unique confluence or pool of knowledge under one roof from its commodity/metal book to the mine. Before it became a public company this proprietary knowledge provided a major competitive advantage. According to the prospectus for its $10bn initial public offering in May 2011, Glencore supplied 60 per cent of the international third-party market in zinc metal and 50 per cent of the international third-party trade in the zinc concentrates market.

Glencore is the world’s top zinc miner at 11.5 percent of global concentrate production and eight percent of refined zinc production. Glencore as a trader also has equity stakes in other producers such as Peru’s Volcan and has a staggering 35 percent of Europe’s zinc smelting capacity. Glencore is now ranked first in smelting with annual production of 1.36 million and is currently nicely balanced on paper at least with its mine production of 1.4 million tonnes. However it does not work that simply. It can and does use its power to move tonnes on the high-seas to where it can find the best return even if that means temporarily parking zinc stocks in warehouses far removed from the end user. So it sells its concentrates to other smelters and buys concentrates from other mines and so gathers market intelligence. The trading of metals provides a defensive capability even when commodity prices are down. What is more is that perils of wisdom from this strategic pool of knowledge are selectively thrown as shiny sparkly things to the swine. All you have to do is listen.


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