COLUMN-LME zinc stocks cancelled - signal or noise?: Andy Home

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Andy Home

LONDON, Sept 19 (Reuters) - The zinc rally has run out of steam.

The galvanising metal is still, just, the second-best performer among the base metals traded on the London Metal Exchange (LME) this year.

But the benchmark LME three-month price has over the last couple of weeks retreated from above $2,400 per tonne to a current $2,260.

Some of the hot money that drove the price higher over June and July has left the market. The LME's Commitments of Traders Report showed money managers trimming their net long position by 12,271 lots, or 306,775 tonnes, in the week to Sept. 12.

Given the likely preponderance of technical funds in that category, this collective rush for the exit may have been no more than a reaction to the loss of upside momentum and the subsequent price decline.

The real problem for zinc's many bull followers is the gap between expectation and reality. The zinc story is one of looming supply crunch as some of the world's biggest mines come to the end of their operating lives. But there is still scant evidence of any stress in the zinc supply chain.

Global mined and refined production are still rising and there are ample stocks of concentrate and metal to fill any emerging gap with demand.

The rally, in other words, had got ahead of the story, leaving the London market vulnerable to precisely the sort of speculative blow-off experienced this month.

However, just at the moment the bulls are pulling in their horns has come a mass cancellation of LME stocks in preparation for physical drawdown. Cancelled tonnage in the system has mushroomed in five days from 52,000 tonnes to 145,650 tonnes. It now accounts for more than 19 percent of all LME inventory.

It's precisely the short of signal an increasingly jaded bull market was hoping for. But is it a "true" signal or just noise?

SIGNAL?

The answer might well be a bit of both, because these cancellations have come in two distinct waves.

The first, totalling almost 20,000 tonnes, has taken place at Detroit and lifted the proportion of cancelled tonnage at this U.S. location to 52 percent.

This zinc has now in all probability joined the load-out queue at Metro (Other OTC: MTRAF - news) , the dominant warehouse operator in Detroit. Although other warehousing companies are active in the city, only Metro held sufficient tonnage at the end of last month to account for such high cancellations, judging by the LME's latest monthly breakdown of stocks by operator.

The queue for metals other than aluminium at Metro stood at 74 days at the end of August, according to the LME. It's probably flexed a bit wider after the zinc cancellations.

But it's not the first time people have been prepared to queue to get zinc out of Detroit. Registered stocks in Motown have fallen by over 60,000 tonnes, or 55 percent, so far this year.

Given Detroit's location in the heart of the U.S. Midwest manufacturing hub, this steady drain of LME inventory chimes well with the recent strength of factory activity in the United States, and particularly with robust auto sales, a key end-use sector for zinc in the form of galvanised steel sheet.

Moreover, Detroit is the only source of LME zinc in the United States, with the exception of New Orleans in the south.

OR NOISE?

New Orleans is where the second tranche of zinc cancellations has taken place. Thursday's daily stocks update by the LME showed 74,000 tonnes of zinc moving into the cancelled category.

It is of course just possible that this metal will be shipped north to Midwest consumers but, given the pattern of stocks movements so far this year, it is far more likely that these cancellations represent the latest turn of the zinc merry-go-round in New Orleans.

Zinc stocks at the port have risen by a net 17,400 tonnes so far this year.

But that modest headline increase masks a very high level of background activity. So far this year there have been 295,000 tonnes of "arrivals" and 277,000 tonnes of "departures".

Long periods of steady draws have been punctuated by sudden, heavy inflows, such as the 87,000 tonnes that were warranted in the first half of August. Bull (Paris: FR0010266601 - news) signals have been cancelled out by bear signals.

Whether anything is actually arriving or departing is difficult to say given the amount of noise being generated by this regular rotation of metal in LME sheds in the city.

Compounding any read-through to underlying market dynamics is the fact that most, if not all, of this movement is taking place at warehouses operated by Pacorini, the warehousing arm of Glencore (Xetra: A1JAGV - news) , a physical powerhouse in the zinc market.

There are four LME warehouse operators in New Orleans but as of the end of last month only two were holding stocks and Metro (SES: E1:M01.SI - news) only 77,275 tonnes in all forms. Pacorini was storing 681,780 tonnes.

Metro, moreover, has seen modest one-way activity over the last five months with 10,550 tonnes of departures across all metals. Pacorini has seen 133,280 tonnes of cumulative inflow and 181,625 tonnes of outflow over the same April-August period.

Zinc in New Orleans, in short, is largely a single-player game.

CONCENTRATION

That's going to hold true for the foreseeable future, because the real "signal" in the zinc stocks picture is the increasing concentration of metal in New Orleans and in Pacorini sheds.

New Orleans accounts for 87 percent of all the zinc in the LME warehouse system, a ratio that rises to 89 percent for open tonnage, even after those recent cancellations.

This is far from a new phenomenon but the ratio keeps edging higher and will carry on doing so as stocks are removed from Detroit, the second-largest concentration of zinc in the system.

New Orleans, remember, is a long way from the U.S. Midwest or indeed from any manufacturing hub.

But it is now where most of the LME-registered zinc is located.

The real significance of this concentration is not on the outright zinc price, despite the potential for more confused signalling as the merry-go-round turns.

Rather, the impact will be on physical premiums, particularly if other sources of LME metal such as those at Detroit are exhausted.

At some stage in the not-so-distant future the market may have cause to need LME-registered stocks in greater quantities. Right now it's looking as if there's going to be only one place to get them.

Oh ... and there may be a queue to load the metal out, if everyone tries to tap the LME system at the same time.

There were no load-out queues at New Orleans last month. There seems to be one now.

(Editing by Dale Hudson)