LONDON: The global lead and zinc markets have both been in supply-demand surplus this year, according to the latest figures from the International Lead and Zinc Study Group (ILZSG).
Lead supply exceeded demand by 32,000 tons in the January-May period, while the global zinc market generated a surplus of 149,000 tons.
Both metals were also in surplus last year and the year before, according to ILZSG calculations.
Superficially at least, this would explain why lead's historic price premium to sister-metal zinc has shrunk dramatically.
Indeed the "normal" relationship between the two has inverted twice so far this year, zinc trading above lead in late March and again in late June.
But on just about any metric lead is a fundamentally sounder market than zinc, which begs the question why the price differential between the "ugly sisters" remains so marginal.
LESS UGLY
Both metals may have been in historical surplus but that in the zinc market has been much larger, totaling a cumulative 1.275 million tons over the 2007-2011 period.
Lead over the same years generated a surplus of just 143,000 tons.
Even now zinc is still generating a significantly higher supply surplus than its sister metal, both in terms of outright volumes and, more tellingly, in terms of market size.
Zinc's estimated surplus in the first five months of this year, for example, represented 14 percent of last year's global usage. That in lead represented a relatively lowly 4 percent of global usage in 2011.
Visible stocks of both metals in the London Metal Exchange (LME) warehouse system are historically high.
Lead stocks have been dribbling lower in recent weeks but they are doing so from an all-time record high of 388,500 tons recorded in October of last year.
Zinc stocks registered with the LME, meanwhile, have just punched up through the one-million-ton level for the first time since 1995.
But even with this surge of zinc onto LME warrant, what is the LME system still accounts for less than half of total stock levels estimated by the ILZSG, which includes in its figures an assessment of inventory held by producers, consumers and merchants.
LME lead stocks, by contrast, still represent around 57 percent of total global stocks of total inventory, using the same methodology.
In other words, we are still seeing more of the global stocks picture in lead than in zinc.
That may seem surprising. But the sporadic front-month tightness that characterized the LME lead market last year sucked in metal from the physical market.
LME lead stocks surged by almost 70 percent, or 143,000 tons, over the course of 2011 with stocks "out there" accordingly shrinking.
There are plenty of statistical pitfalls with this type of analysis, not least the difficulties assessing off-market stocks and official Chinese production figures.
But potential anomalies should apply equally, given the same source of the statistics and the fact that at a primary level zinc and lead are sister metals, tending to be mined together and smelted by the same producers.
SINKING TOGETHER
There is of course an argument that just as a rising tide lifts all boats, so does an ebbing one cause all boats to sink together.
All of the LME base metals have fallen this year as the market frets about the deteriorating global growth outlook and the potential impact on cross-metals demand, first and foremost in China.
However, the curious thing is that lead should be far more resilient to slowing macroeconomic growth than zinc.
The latter's use in galvanized steel leverages it to construction, even in China a problematic part of the metals demand equation right now.
Lead's main usage derives from batteries. That means it is more vulnerable to slowing new automotive output, but replacement batteries are also an important part of its usage profile and one that is effectively recession-proof. Batteries fail, irrespective of economic cycle.
Neither metal is yet at a price where producers feel sufficient pain to cut back production, although there has been a noticeable slowdown of refined zinc production growth in China since the start of 2011.
As such, current market balance trends should continue, meaning zinc will keep generating a greater supply surplus than its heavy sister.
Indeed, some analysts argue that lead is already moving close to balance with the potential for a supply deficit to emerge next year. No-one is expecting zinc to shift into deficit any time soon.
Even zinc bulls aren't expecting any significant tightening of market balance until the scheduled closure of major mines such as Brunswick in Canada and Century in Australia feeds through into the refined market, a process that is expected to take at least a couple of years.
And one that is subject to continued delays, witness the extension of the mine-life at Century from 2015 to 2016.
— Andy Home is a Reuters columnist. The opinions expressed are his own.
WHICH IS MISPRICED?
Failing a convincing fundamental argument as to why lead is not trading significantly higher than zinc, the best explanation is that it is probably to do with market structure.
Earlier this year some of the disparity between the two was explained by the unwinding of a short-zinc/long lead relative play strategy.
It was a plausible explanation for lead's underperformance and zinc's outperformance in the first part of the year but one that surely can no longer apply.
Now, however, there is a new factor in play.
The zinc spreads are tightening, the benchmark cash-to-three-month period flitting in and out of backwardation in recent days.
Large amounts of metal have been cancelled at New Orleans, which dominates the LME zinc stocks picture.
And equally dominant is the entity in the LME market reports that controls 50-80 percent of all LME zinc stocks and a similar portion of warrant/cash/tom-next positions relative to stocks.
It is one reason why so much zinc is now hitting the LME system, just as was the case during the sporadic lead squeezes of 2011.
Could it be that this dominant long and the concentration of LME zinc stocks in just one location, New Orleans, is artificially inflating the price?
It's an interesting thought.
Because one of these two metals is mispriced, it's just a case of which one.
The analyst consensus is that lead has the stronger fundamentals. Once these reassert themselves, so the argument runs, it will be the out-performer.
It is in essence a bull call on the lead price.
The alternative, and a less appealing one for bulls of any persuasion, is that lead is correctly priced in the current macro climate and has little real upside potential.
That would mean that it is zinc that is mispriced, implying that once the dominant long position loosens its grip, the zinc price has further downside potential.
Either way, these two trading at close to parity is clearly anomalous. It is time for the two "ugly" sisters to go their separate ways.
— Andy Home is a Reuters columnist. The opinions expressed are his own.
Time for lead and zinc to go their separate ways?
