Zinc Bull Market
The recent and infamous scourging of the price of oil off its July highs has taken its toll on the greater commodities markets. Commodities losses in this time have left a bad taste in investors' mouths and have given fuel to a vicious Wall Street campaign that touts the end of the commodities bull market.
Oil has fallen around $20 per barrel in the last three months, shaving over 25% of its value, and has taken other commodities along for the ride. From the date of the oil high, gold had dropped over $100 per ounce to its recent October low losing 16% itself before a slight recovery in the last few weeks. And the stocks of the oil and gold companies have also plunged in sympathy.
But through the fog of commodities hate lie the few exceptions that have bucked the trend. While energy and precious metals have taken a beating in recent months, base metals have remained strong with several of them even eclipsing all-time highs.
Base metals are those industrial metals that have been so pivotal in the massive build-out of the global economy led by Asia. And as with the fundamentals driving the movement of energy and precious metals prices, supply and demand imbalances have found their way into the base metals realm.
There is a finite supply of base metals in the earth and the process of extracting them is very capital intensive and time consuming. So when growing demand for these metals outpaces supply on a recurring basis, an economic imbalance creates itself. This imbalance drives up prices until either demand shrinks or supply is able to catch up with it, ultimately creating sustainable surpluses.
In the last few years, even with year-over-year increases in production on the mining front for all the base metals, suppliers have not been able to keep pace with demand. And though this imbalance is supposed to tighten in the coming years as the global economy takes a breather, shortfalls are still expected.
Copper has taken the limelight among the base metals as an investor favorite and has held strong over the last few months hovering around the $3.50 per pound level as global supply disruptions continue to surface. And aluminum has been consolidating nicely following its May spike that surpassed its previous all-time high in the late 1980s.
After a bumpy ride the first half of this year, lead has had an incredible run since June rocketing 81% higher and exceeding its all-time nominal high just this month. And nickel has hardly let up since June as it also continues to shatter its highs. I recently penned an essay focused on nickel that highlights the incredible fundamentals for this metal.
The next major base metal that I'd like to focus on is zinc. Zinc just recently achieved a nominal all-time high and along with its fellow base metals counterparts has bucked the commodities trend in recent months. Zinc has had just an amazing run in its own bull market. From its 2003 low of $0.34 per pound, zinc has climbed an incredible 479% to a new all-time high of $1.95 per pound just achieved a few days ago.
Even with this enormous gain, zinc's importance and future potential is still relatively unknown to most investors. The largest and most important application of zinc is its use in galvanizing steel which protects the steel from corrosion. Zinc's galvanizing effects have been measured to increase steel's life by a factor of five.
Interestingly, according to a study that Battelle Laboratories performed in 1995 updating a National Bureau of Standards study in the 1970s, metallic corrosion costs the U.S. over $300 billion per year, which is in excess of 4% of the GNP. While the average person thinks of zinc as a primary vitamin supplement, in reality its economic implications are staggering.
Other major uses for zinc include its utility in brass and bronze among many alloys, die casting, batteries, chemical compounds such as paint, ceramics and pharmaceuticals. Zinc's many different applications rank it as the 4th most common metal in use behind iron, aluminum and copper.
And most people do not realize that the U.S. penny is actually made of copper-plated rolled zinc, which consists of 97.5% zinc and only 2.5% copper. Pennies have been made in this fashion since 1982, which was a good move by the mint since copper is worth twice as much as zinc. And interestingly, even though the penny is loaded with the cheaper of its two ingredients, with today's commodities prices coupled with production expenses, it costs about 30% more than face value to actually produce a penny.
On top of its minting phenomenon, the fundamentals of zinc are very strong to support its continued bull market. According to the International Lead and Zinc Study Group (ILZSG), global zinc consumption is expected to rise by 3.9% this year and is estimated to rise by 2.6% in 2007. Even though total metal output is forecasted to increase by 4.9% next year, a supply deficit is still expected by many industry experts.
China is by far the world's largest zinc consumer as it accounts for 30% of total global consumption, more than three times that of the next closest country, the United States. And the ILZSG expects China's zinc demand to increase by a massive 6.9% next year, further exacerbating the global supply crunch.
As mentioned, zinc producers have increased their year-over-year output to better supply the market. In fact, since 1995 the global mined production of zinc has increased by 42%. But even with this impressive increase, demand has outpaced the best the producers have had to offer.
Another reason for zinc's sharp rise in the last couple years revolves around its London Metal Exchange (LME) stock levels. The LME is the largest non-ferrous metals exchange in the world. And of its major functions to provide daily prices for the base metals and provide the market for futures and traded-options contracts, the physical storage of these traded contracts serves an extremely important role.
Last month I wrote an essay that looked at the stock levels and prices of each of the base metals to see how they correlated. It makes sense that as global inventories of a metal decrease, prices would rise as a result of the thin physical supply. And the graphical depictions of this scenario revealed incredible insight into the base metals run the last couple years.
As you can see in the chart above, LME zinc stock has taken a dive this year. Over 280,000 metric tons of zinc have come off the top as consumers not being fulfilled by the suppliers are pilfering the warehouses to satiate their demand. Zinc stock has fallen by 73% so far in 2006 and does not seem to be stabilizing as it continues knifing downwards.
Interestingly, as recent as May 2004, LME zinc stock tallied 770,000 metric tons. At today's levels this means global zinc stock is down 86% in just over two years! At its 108,000 metric ton level today, warehoused zinc is only sufficient to provide about four days of global consumption. These are alarmingly low stock levels and they indeed provide legitimate justification to the high zinc prices we are seeing today. Zinc fundamentals weigh heavily on its price action as is apparent by this inverse correlation of falling stock and rising price.
Back in May when gold and silver peaked, many of the base metals including zinc exhibited sympathetic weakness as they began to correct off of their interim highs. But when oil joined the party and started tumbling from its July highs, the base metals shrugged off the continued commodities weakness. While gold continued to fall in sympathy with oil, zinc trended higher not only making up its sympathetic gold losses but just recently achieving yet another all-time high.
Zinc's bull market has been quite remarkable. After a long bear market that forced zinc down to its 2002-2003 lows, it has caught quite a bid. Base metals lagged behind the precious metals a bit before they started their run, but as you can see represented by zinc's magical four-year performance below, the global economy has dictated a wild and exciting bull run for the base metals.
From the beginning of 2003, the zinc market really started to tighten leading the way for this metal to ride an orderly and textbook uptrend for nearly three years. An environment conducive to rising prices was starting to establish enough precedent to turn the heads of commodities speculators. And when speculators finally started to see the fundamental writing on the wall and could no longer downplay Asia's economic impact on the natural resources front, zinc skyrocketed in parabolic fashion.
This sharp rise worried many speculators, including myself, that a swift and sharp correction would follow bringing zinc back down below its 200dma and perhaps all the way down to its original trend channel. But fortunately this has not happened. And this comes as quite a surprise as parabolic price rises are nearly always followed by sharp corrections in order to balance sentiment and wipe euphoria from the floor.
But zinc, along with the rest of the base metals, is not ready to give up its ghost quite yet. After zinc's parabola climaxed in May, a mild correction indeed ensued. But as you can see in the chart above, zinc has shown remarkable strength as it has trended higher off its May top to eventually surpass the apex in just a matter of months.
In addition to the simple economic fundamentals that have been driving zinc's young bull market, future zinc-mining prospects are bleak which should provide the bull continued longevity. Just a few years ago, many of the major zinc mines around the globe were barely breaking even with zinc prices in the $0.30 per pound range. The price of zinc was so low for so long that miners had little incentive to put forth the massive capital required to expand existing deposits and explore for new ones.
Though mining output has been on the rise, much of this can be attributed to increases in same-mine output and the reopening of previously decommissioned mines to take advantage of these now high zinc prices. And even though some high-quality zinc mines are coming online in the coming years, some of the more mature primary zinc mines are living out the latter halves of their lives. Many more zinc deposits will need to be discovered and mines built in order to maintain and grow supply to meet future demand. The evolution of a zinc mine takes significant time and capital and continued high zinc prices are going to be what allows this to happen.
As a speculator who understands zinc's fundamentals and is witnessing its awe-inspiring price action, the opportunities that arise from this have me chomping at the bit. This zinc and in general base metals bull market has made futures traders betting in the right direction barrels of money. But what is still not widely known is that the average investor can take part in this powerful bull by acquiring the stocks of the explorers and producers that are charged with bringing these popular base metals to market now and in the future.
With today's prices, most producing zinc mines that were able to hang in there through the bear market are able to bring their zinc to market at excellent margins. And the resilient zinc miners that were making profits at $0.35 per pound zinc that are leveraged to the price action of their underlying metal are able to score incredible profits in today's environment.
But looking at the charts above, it's easy to wonder if zinc is perhaps overbought and how much of a speculative premium is built into today's price. I believe the markets can support the current zinc price, but even if zinc temporarily corrects to balance sentiment and gather itself up for another upleg, zinc producers are still positioned to greatly profit. And with metals prices currently hovering around record highs, producer companies are continuing to yield record profits for their shareholders.
In the same fashion that gold and silver stocks caught their bid as the precious metals took off, base metals stocks have incredible potential going forward. But unlike gold and silver stocks, most base metals stocks still exhibit obscenely low valuations and are ripe for the picking. In fact, many base metals stocks are still trading at bear-market multiples even today.
Even though many base metals stocks have enjoyed good initial run-ups in this young bull market, they still lie in relatively undiscovered territory for most investors and speculators. As the word gets out that base metals stocks are still cheap, capital should flood into them eventually driving their values to appropriate bull market levels greatly rewarding those prudent ones that were in the door first. With this in mind, we've been researching base metals stocks all summer wading through the hundreds that are out there on a quest to discover the best fundamental plays.
We have recently published another of our comprehensive research reports that identifies our favorite 20 base metals stocks. These research reports contain detailed fundamental discussions on the individual stocks we believe have a high potential for success in various sectors within the commodities bull market. Included in this base metals stocks report are not only a handful of very promising and undervalued zinc plays, but those companies that focus on copper, nickel, lead and molybdenum among the many base metals.
The stocks highlighted in this report range from small-cap junior explorers to major producers. This inside look at our research provides a sample of what we deem the best of the best base metals stocks ultimately designed to support current and future base metals stock trades for our newsletter subscribers. If you are interested in getting an inside look into our favorite base metals stocks, please purchase our latest report today.
The bottom line is zinc is indeed one of today's hottest commodities. As this metal's global imbalance works to correct itself, prices should continue to stay high for many more years. With this, the suppliers that are bringing zinc to market now and in the future are positioned to achieve vast profits.
And investors and speculators wishing to take part in this excellent bull market not only in zinc but in any of the base metals can multiply their capital through the elite companies that discover and extract the various metals from the earth. Base metals stocks are still cheap, and a continued bull market in these metals should drive them considerably higher.