(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
LONDON, May 11 (Reuters) - Investors are stampeding back into the London zinc market.
Their return has triggered a super-charged rally in prices. On the London Metal Exchange (LME), three-month metal has soared from under $2,000 per tonne in mid-March to last week's highs above $2,400 per tonne.
Spreads have tightened as shorts scramble to cover positions in the face of a dominant long position controlling somewhere between 40 and 50 percent of non-cancelled LME stocks .
LME stocks, meanwhile, continue to fall at a steady pace. They are now down by around 35 percent, or 239,000 tonnes, since the start of the year.
All the signals, in other words, appear to be turning bullish, rekindling interest in zinc's long-running bull story of mine closures and looming supply shortfall.
But we've been here before.
A similar burst of speculative interest in the galvanising metal caused a sharp rally in the second quarter of 2014, only for bullish enthusiasm to dissipate over the second half of the year.
It's by no means clear whether this year's return of the money men will end any differently.
MONEY MEN RETURN
The LME has been publishing its U.S.-style Commitments of Traders Report (COTR) since last July.
And although there are still plenty of nagging doubts as to just how accurate it is in terms of fund positioning, it is the best independent gauge we have.
As of May 1, the last date for which figures are available, the LME's COTR showed money managers holding net long zinc positions of 90,940 lots, representing 21 percent of open interest.
That's the highest level of fund long positioning in any of the core base metals traded on the LME.
It's also the highest zinc long positioning since August last year and reflects a massive net build of over 55,000 lots, or almost 1.4 million tonnes, since the middle of March.
****************************************************** Graphic on money manager positioning in LME zinc: http://link.reuters.com/qyd74w ******************************************************
Such heavy investment flows can become a price driver in themselves, fuelling upside chart momentum and tightening the LME forward curve as short-position holders are forced out, borrowing spreads to align dates as they do so.
The benchmark cash-to-three-month period flexed out to $33 backwardation at one stage last week, the tightest it's been in a year.
That flash squeeze has abated a little but cash-date tightness is still evident in the form of a small backwardation on the "tom-next" spread, the shortest-dated spread in the LME's trading calendar. It was trading in a range of $0.50 contango to $7.50 backwardation this morning.
But are the money men chasing their own shadows?
Look beyond the impact of the positioning shift over the last couple of months and it's not clear whether anything has really changed in this market.
That's particularly true of the LME stocks picture, which has been one of steadily dwindling exchange-registered inventory for many months.
But does this apparently bullish downtrend reflect anything more than metal being relocated to off-exchange storage rather than plugging a supply-demand gap in the physical market?
Doubts about the validity of the LME zinc stocks signal are accentuated by the fact that so much zinc inventory (90 percent) is in just one location, New Orleans, where so much LME inventory (98 percent at the end of March) is held by one operator, Pacorini, the LME storage arm of Swiss powerhouse Glencore (Xetra: A1JAGV - news) .
New Orleans has long acted as a sinkhole in physical zinc storage and the current particularly high levels of concentration work against any read-through to broader supply-demand dynamics.
One thing is for sure, though.
A significant part of the LME stocks decline so far this year has been offset by the rise in stocks registered with the Shanghai Futures Exchange.
These are up by almost 111,000 tonnes at a current 194,505 tonnes, suggesting that there is no tightness in at least one part of the world.
MAYBE NEXT YEAR
Well, at least zinc's newly returned fund supporters can draw strength from the underlying story of mine closures and a tightening raw materials sector.
Or can they?
It's true that the giant Century mine in Australia will finally reach the end of its life this year, having apparently run out of extension options.
And it will be joined by Lisheen, another big zinc mine in Ireland (Other OTC: IRLD - news) . Lisheen's owner, Vedanta Resources (Other OTC: VDNRF - news) , confirmed in its Q1 production report that the mine will cease operations around the third quarter of this year.
But such losses to global zinc mine supply appear not to be tightening the zinc concentrates market.
The best indicator of what's happening in this part of the zinc supply chain are the benchmark 2015 concentrate terms.
These have just widened over 2014 levels, suggesting famine rather than feast.
According to Belgian's Nyrstar (Brussels: NYR.BR - news) , one of the world's largest producers of refined zinc, the benchmark treatment term for this year was set at $245 per tonne, up from $223 per tonne in 2014, with no change to the basis price ($2,000 per tonne).
Such treatment terms denote how much a smelter pays the miner for processing concentrates into metal. The higher the charge, the better implied level of availability.
All of which may seem counterintuitive until you factor in the projections made by the International Lead and Zinc Study Group (ILZSG) at its spring meeting.
While conceding the hits on supply arising from mine closures such as those at Century and Lisheen, the ILZSG still forecast global mine production to rise by 3.7 percent to 13.84 million tonnes this year.
That represents accelerated growth from last year's anaemic 1.0 percent rise in mine supply and reflects major expansions in Australia and India in particular.
Sure, the ILZSG is also forecasting a 151,000-tonne supply-demand shortfall in the refined metal part of the market, but that marked a significant downgrade of the deficit expected at the group's prior meeting in October 2014.
And the key takeaway is that it will not result directly from raw materials supply stress, which forms the core of the bull market narrative for zinc.
Maybe next year as more mines close, but "maybe next year" was one of the reasons zinc's 2014 rally ground to a halt as investors lost patience with what has turned out to be a remarkably slow-burn story.
This market has been chasing deficit dreams for a long time now and other than the highly questionable signal coming from LME stocks, deficit remains a curiously elusive phenomenon.
Still, maybe this will be the year when it really takes tangible form.
Big emphasis on that word "maybe".
(Editing by Dale Hudson)