COLUMN-Nyrstar makes the (deferred) bull case for zinc: Andy Home

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

By Andy Home

LONDON, Feb 11 (Reuters) - Zinc was the best relative performer of the base metals pack traded on the London Metal Exchange (LME) last year.

And so it is proving again in the early part of 2014, even allowing for three-month metal's retreat from a late-January high of $2,102 per tonne to a current $2,006.

To understand why you need only listen to the conference call accompanying the Q4 2013 results of Nyrstar (Other OTC: NYRSY - news) , the largest refined producer of the galvanising metal outside of China.

The Belgian company might be forgiven for tending towards an overly optimistic view, particularly after zinc's long years in the dog-house, when the price was suppressed by supply surplus and high legacy inventory.

But Nyrstar's leading production position, enhanced by a newly-forged marketing presence following the demise of the offtake agreement with Glencore, means it is uniquely placed to back up its bullish take on the zinc price outlook.

Just one caveat, though.

Right now, it is a "seller", having just completed another strategic hedging programme.

The good times may be coming but, it warned, there may be a lot of price volatility first.

BULLISH SUPPLY STORY

"We have been anticipating a structural change on the supply side of zinc fundamentals for a while and I think it's pretty fair to say that that is currently happening and happening in a very pronounced way across the sector," said Bob Katsiouleris, Nyrstar's SVP for marketing, sourcing and sales.

For "structural change", read the well-flagged closure of some of the world's largest zinc mines.

A timely reminder of that process came with this morning's production report from Glencore-Xstrata, another powerhouse in the zinc sector.

Two of the company's Canadian mines, Brunswick (Munich: BWI.MU - news) and Perseverance, reached the end of their operating lives last year and the result was a nine-percent decline, equivalent to around 133,000 tonnes, in group production.

Glencore-Xstrata is compensating by expanding its Australian operations and bringing on new mines such as Perkoa in Burkina Faso. It is confident that its zinc production will start growing again next year.

Others may find it more difficult to follow suit.

The giant Century (Shenzhen: 300078.SZ - news) mine in Australia, owned by China's MMG , will run dry around the middle of 2015 but plans to partly offset the loss with the development of another zinc asset, Dugald River, have been thrown off track by technical challenges.

Nyrstar itself is finding out how difficult it is to bring on new and revamp old mines. The company, committed to bulking up its own raw materials feed, reported a four-percent decline in mined production last year.

And that's not counting the stream of concentrates from the troubled Talvivaara mine in Finland, currently undergoing a financial rescue plan, in which Nyrstar itself is actively involved.

BULLISH DEMAND STORY

Such is the troubled zinc supply landscape and it is this compelling story of looming mine deficit that has really grabbed the "LME Street's" attention over the last few months.

What Nyrstar added to the narrative was an upbeat assessment of what is happening on the usage side of the equation.

"We're starting to see evidence of improvements in demand," across all three major geographic regions, said Nyrstar's Katsiouleris.

Indeed, in terms of the U.S. and European construction sectors, demand is at levels "we have not seen since pre-crisis, typically 2006 or so".

Orders from European construction customers have increased by 20-30 percent over the back end of 2013 and the start of 2014, while U.S. demand for galvanising-grade metal has also notedly picked up, Nystar said.

China continues to soak up metal from the rest of the world. Net (Dusseldorf: NETK.DU - news) imports last year were 621,000 tonnes, up 22 percent, bucking a broader trend of reduced call on metal by the world's largest consumer.

Although some of those imports are believed to have gone to meet financing rather than manufacturing demand, Nyrstar made the interesting point that China is itself becoming a major exporter of galvanised sheet, aggressively targeting markets such as Latin America.

The manifestation of these stronger demand trends is the increase in physical market premiums over and above the LME basis price. Those in Europe, for example, hit five-year highs last month.

STILL A HEDGE SELL?

All of which explains why, to quote Katsiouleris, "we still believe that the fundamentals leading into 2014 and 2015 are robust both on the structural (supply side) and on the demand side."

Before then, though, "we see zinc probably in a very volatile environment", reflecting a shifting supply landscape, regional variation in demand patterns and, not least, the potential fall-out from the LME's warehousing rule changes, which may lead to accelerated drawdowns from May.

Which is why Nyrstar has instituted a zinc price hedging programme similar in style to that it conducted early last year.

The company confirmed that it took advantage of the recent price spike both to sell forward zinc and to buy put options.

The forward sales, covering around 17,000-20,000 tonnes per month in February and March, locked in a price between $2,060 and $2,080 per tonne.

The options package, covering the second quarter, has achieved a "floor" price of $2,050 per tonne for a similar monthly tonnage.

The nature of such an options strategy, of course, is that it keeps open any exposure to upside movement, a neat way for a producer to quite literally hedge its bets.

But taken in the round what Nyrstar has done suggests that it isn't banking on a sustained price rally until further down the line, and certainly not until the second half of this year.

ACTIONS AND WORDS

It's an important rider to the zinc bull narrative from an important player in the zinc market.

While the sequencing of mine closures will be easy to track, there is much greater uncertainty surrounding producers' collective ability to react over the coming couple of years.

Moreover, there is still the tricky question of just how much legacy stock exists to cushion any supply shortfall.

LME stocks have been trending steadily lower since the start of this year but is the metal leaving to meet manufacturing demand or to meet off-market financing demand?

It's hard to say and the picture will become muddier, if those stocks start leaving at a faster rate because of the LME's new load-out rules.

But for long-suffering zinc bulls the picture painted by Nyrstar is an appealing one, and one which will no doubt be woven into the market's emerging bull narrative.

Just remember that in terms of timing, Nyrstar's actions may speak louder than its words. (Editing by Anthony Barker)