(The opinions expressed here are those of the author, a columnist for Reuters.)
By Andy Home
SINGAPORE, May 26 (Reuters) - Appearances can be deceptive and never more so than when it comes to trading on the London Metal Exchange (LME).
As zinc bulls have just found out.
Three-month metal was on a surge last month, powering up from a March low of $1,981.00 per tonne to an early May high of $2,404.50.
Money managers were rushing to join the action, lifting their collective long positioning from under 10 percent to over 20 percent of open interest.
LME stocks were falling daily and the front part of the spread was tightening, two apparently reinforcing bull indicators.
Alas, it was all deception.
Last week's delivery of 36,375 tonnes of zinc onto warrant at Johor in Malaysia blew away the tightness and sent three-month metal tumbling back down to $2,178.00 at Friday's close.
It has served, yet again, as a reminder that LME stock movements can be poor signals of underlying market dynamics.
The zinc market has been caught out before by such sudden surges of metal into the LME system.
Moreover, it is proof, yet again, that zinc's bull story of pending supply deficit is one of future expectations rather than present reality.
STAND AND DELIVER
It's no coincidence that the flow of metal onto warrant at Johor happened last week. That was the LME's prime third-Wednesday prompt date for May.
The preceding days had seen a sharp tightening across the front part of the curve.
The benchmark cash-to-three-months period had flexed out to $33.00-per tonne backwardation. The "tom-next" spread , the shortest-dated spread in the LME trading system and the best indicator of cash-date tension, had also flipped into volatile backwardation.
A dominant long position holder was turning the screws on short position holders but one of them at least opted not to roll but to stand and deliver.
****************************************************** Graphic on LME zinc spreads ahead of May prompt date: http://link.reuters.com/gyx74w ******************************************************
There is plenty of potential for repeat performances in the months ahead.
The LME's futures banding report shows clusters of sizeable positions, both long and short, sitting on the prime prompt dates of the next three months.
Any or all of them could result in renewed spread tension and further large deliveries of metal onto LME warrant.
Which rather begs the question of just how much more zinc is sitting off market in the statistical shadow-lands.
One thing is for sure.
The daily draws of metal from New Orleans, which until last week was where most of the exchange zinc stocks were concentrated, have been generating a false signal.
This should really come as no big surprise.
Analysts such as David Wilson at Citi had been sounding increasingly urgent warnings.
The title of Citi's May 19 research note, "Zinc and Lead - Don't believe the draw trends", speaks for itself.
The most telling clue that things were not quite as they seemed was the fact that these draws resulted from massive single-day cancellations of LME warrants.
When someone moves 91,400 tonnes of zinc off warrant in preparation for physical drawdown, as happened on Feb. 11, it stretches credulity to think that this is about meeting just-in-time manufacturing demand.
Such large-volume movements signify, rather, storage arbitrage with metal being moved to cheaper off-LME warehouses, a shadowy trade which is interwoven with competition between warehouse operators for units and rental revenue.
Indeed, every other zinc market indicator has been pointing to oversupply rather than market shortfall.
Chinese zinc production has been booming, up 13.6 percent in the first four months of this year, according to figures from the National Bureau of Statistics.
Chinese zinc demand, however, hasn't been booming.
Citi notes that production of galvanised steel, a key component of zinc's usage profile, was up just 6.4 percent in the first quarter of 2015.
And even that figure may be painting an over-optimistic picture of Chinese demand, given that exports of galvanised steel jumped by 35 percent in the first three months of this year.
China is in part exporting surplus zinc to the rest of the world in this way with more surplus flowing into SHFE warehouses.
As for the global picture, the latest assessment by the International Lead and Zinc Study Group is that the refined zinc market is in supply surplus.
It pegged that surplus at 37,500 tonnes in March and at a cumulative 140,600 tonnes over the first three months.
Chinese financiers have historically been a taker of surplus metal from the rest of the world but with the collateral financing model melting after the Qingdao scandal, imports have fallen 70 percent to 80,100 tonnes so far this year.
The inference is that there is more metal accumulating in the statistical darkness elsewhere.
WON'T GET FOOLED AGAIN?
It took the May mini-squeeze on the LME to pull some of that surplus into the exchange light.
And more may show up if availability is tested by renewed spread tightness over the coming months.
LME stocks in New Orleans, meanwhile, will continue to fall on a daily basis. There are still 67,875 tonnes of cancelled zinc awaiting load-out at the U.S. port.
This contrarian signal, in other words, will continue transmitting and as long as it does, would-be zinc bulls, and there are many of them, risk falling into the gap between appearance and reality.
Maybe for the money men, it's a case of won't get fooled again?
Maybe, but don't bet on it. (Editing by Richard Pullin)