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COLUMN-Zinc shines amid the gloom but what lurks in New Orleans? Andy Home

(Repeats with no changes. The opinions expressed here are those of the author, a columnist for Reuters)

By Andy Home

LONDON, Feb 5 (Reuters) - Zinc is the stand-out amid the general industrial metals gloom right now.

In a world worried about the state of demand, first and foremost in China, the differentiator of price performance is supply.

And zinc is further down the road of supply adjustment than any other metal. It helps that big mines such as Century (Shenzhen: 300078.SZ - news) in Australia and Lisheen in Ireland (Other OTC: IRLD - news) have just reached the end of their natural lives.

The resulting tightening of the raw materials chain has been accelerated by Glencore (Xetra: A1JAGV - news) 's decision to mothball 500,000 tonnes of mine capacity.

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That has sent tremors rippling along the supply chain with Chinese smelters cutting metal output by a similar amount and Chinese imports of zinc surging in the closing weeks of 2015.

Now (Other OTC: NWPN - news) a new, largely unexpected, ingredient has been thrown into the supply mix in the form of Horsehead Holding (NasdaqGS: ZINC - news) 's shuttering of its zinc plant in North Carolina and subsequent filing for Chapter 11 bankruptcy.

The news has galvanised the zinc price. On the London Metal Exchange (LME) metal for three-month delivery has surged to a three-month high of $1,728 per tonne and zinc is by some margin the best performer of the base metals pack this year.

So far so good for the galvanising metal. But zinc bulls have been caught out before. Because casting a long shadow over zinc's sunnier prospects are the shadowy stocks lurking in the city of New Orleans.

HORSEHEAD WOES

The zinc market was blind-sided by the Horsehead news, largely because it is a secondary producer.

Rather than using mined concentrates as raw feed, it recycles electric arc furnace dust from steel mills with the resulting intermediate product sent to its new Mooresboro plant in North Carolina for processing into finished metal.

As such it was not an obvious closure candidate for a market that has been counting up the mine supply hits from natural attrition and low zinc prices.

Horsehead is a veteran of the zinc business, boasting 150 years of operation, although it's not the first time it has had to seek bankruptcy protection from creditors, It happened in 2002, another period of low metals prices.

And the warning signs have been there for some time.

Specifically, Horsehead has struggled to get to grips with its new plant in Mooresboro. It has nameplate capacity of 155,000 tonnes per year but produced just 30,000 tonnes in the first nine months of 2015, its second year of operation.

Reporting on Q3 operations, which included significant amounts of downtime and maintenance repairs, Horsehead warned that "we are not able to predict the impact of these improvements on the rate of production going forward, and expect to have intermittent disruptions to the production rate as we continue to implement solutions."

This is often the way of things during periods of low prices. The first to be hit are those struggling with existing operational or financial headwinds and Horsehead had plenty of problems on both fronts.

NEW ORLEANS SHADOWS

The impact of the Mooresboro closure on the zinc supply picture is pretty marginal, not least because of its protracted start-up problems.

But it's added fuel to an already smouldering fire and zinc's fast-evolving supply dynamics have caught the attention of investors, who have largely shunned a sector so closely intertwined with the all-pervading story of Chinese slowdown.

Supply adjustment is only one half of the price recovery story, though. The other half is the amount of stock overhang that needs to be cleared.

And there is a lot of zinc sitting in warehouses in New (KOSDAQ: 160550.KQ - news) Orleans.

The "Big Easy" has long been the dumping ground for unwanted zinc because of its geographical isolation from physical trading hubs in the rest of the world.

When Hurricane Katrina laid waste New Orleans in 2005, over 70,000 tonnes of zinc stored in LME warehouses were invalidated because of flood damage.

And right now New Orleans holds 376,225 tonnes of LME-registered zinc, equivalent to 81 percent of the global total.

That's only what's visible.

There's more, possibly a lot more, sitting in off-exchange storage.

New Orleans zinc stock movements are a veritable merry-go-round with metal departing daily only to reappear in huge quantities every now and again.

For example, LME zinc stocks in New Orleans fell by 250,775 tonnes last year, an impressive number that looked a little less impressive when 40,000 tonnes suddenly "arrived" over two days in January.

"Arrived" in inverted commas because the chances are this 40,000-tonne clip of metal had never really departed New Orleans in the first place.

FEASTING ON SURPLUS

Rather, this shuffling of metal in and out of LME warehouses is all about stock financiers shopping around for the cheapest storage rents. The lower the cost of storage, the greater the profits that can be made from financing via time-spreads along the LME forward curve.

That also makes New Orleans a battle-ground for warehouse operators trying to attract as much metal as possible into their sheds.

Pacorini, the LME logistics arm of Glencore, used to dominate zinc storage in the city.

But competition has heated up. ISTIM Metals, the latest warehousing incarnation of Bill Whelan, the man behind Metro (Other OTC: MTAGF - news) , has muscled into the New Orleans storage scene.

ISTIM took in around 180,000 tonnes of zinc over the course of August and September last year, although somewhat inevitably, a large tranche was immediately cancelled and has been "leaving" ever since.

Such rental competition and the resulting mass movement of metal into and out of LME sheds makes estimating how much zinc is really in New Orleans a nigh impossible task.

Zinc bulls have been caught out by the New Orleans metals shuffle before. Long periods of falling inventory have tantalised with their promise of a tightening market, only for bullish expectations to be dashed by the mass re-warranting of metal.

The key point to remember is that both financiers and warehouse operators profit from metal surplus, not famine.

And the real message from this New Orleans zinc carousel is that there is still plenty of surplus for them to feast on.

How much exactly is the big "known unknown" in the zinc market.

But until large tonnages of metal stop showing up in New Orleans, it's a fair bet that tightening supply dynamics haven't yet translated into a drawdown of the zinc market's stocks overhang. (Editing by David Evans)