The World Famous "Fence Wizard": Guest Columnist Jason Hommel describes the Zinc Price problem.

Wednesday, December 6, 2006

Guest Columnist Jason Hommel describes the Zinc Price problem.

Zinc Mystery Unveiled?

By Jason Hommel
06 Dec 2006 at 06:22 PM GMT-05:00

GRASS VALLEY, Calif. (Silver Stock Report) -- I have been perplexed as to why LME zinc inventories are continuing to rapidly shrink, with the current high price for zinc having so little impact to discourage zinc depletion. It's like watching a train wreck in slow motion. Aren't high prices supposed to slow down consumption?

As I have explained previously, zinc inventories of 85,000 tonnes will last about 85 days at current depletion rates, whereas zinc inventories need to last about 700 days, or two years until new zinc projects come on stream.

See: Zinc Prices set to continue to explode

Why can't the owners of zinc figure this out?

This appears to indicate that we will see an explosion of zinc prices within the next three months, in my opinion, which is needed to slow or halt inventory declines. But why are zinc prices not already higher--high enough to slow down the inventory drawdown to sustainable levels? What explains why zinc inventory drawdowns are seemingly not affected by the existing high zinc prices? How much higher do zinc prices need to go? What is going on in the zinc market?

About 60% of zinc is used is galvanized steel. Zinc is about 3% by weight of galvanized steel, on average. Since zinc is a minor ingredient in steel, the market can sustain and tolerate and absorb substantial price increases. I explained this previously, in my article where I noted that zinc was up by "60% in 60 days!"

So, moderately higher prices will not significantly slow down demand, and are already high enough to stimulate explorers and investors--even though it takes years to set up a large scale mining operation like you see on "Modern Marvels".

But here's something else to consider.

How much zinc is traded on the spot market verses the futures markets? I don't know. Derivatives can be a big problem, and in my opinion, may be thwarting the free market process whereby higher prices are supposed to cause reduced demand.

Perhaps many end users are not paying $2/lb. for zinc at all! Perhaps many end users are still only paying about 50 cents per pound of zinc! And thus, there is still little incentive for many zinc consumers to conserve zinc usage. How is this possible? Stupid miners hedged! Apex Silver and Penoles are two miners that I know of that have hedged zinc. But how widespread was this practice, and how much damage has it caused, and will it yet cause? I don't yet know, but perhaps someone else will find out.

Apex Silver hedged, 358,150 tonnes of zinc x x 2204lbs./tonne = 789 million pounds.

Since Apex hedged zinc at around $.48/lb., at $2.04/lb. for zinc, that's a mark-to-market loss of $1.56/lb., or $1.2 billion dollars, since Apex still has not yet started to mine any zinc. That's a larger loss than the market cap of Apex Silver! Apex also has losses on the silver and lead. Apex also sold 1/3 of their hedging liability, and 1/3 of their project to Sumitomo. Apex has not yet covered the majority of their hedges, claiming that their future losses will be realized as they come due, since they hedged 358,150 tonnes of zinc, silver, and lead for up to 7 years.

So, Apex may be providing zinc to the market at well below free market prices, about 51,000 tonnes per year, at $.50/lb., for the next 7 years. Perhaps some fortunate end user who will have a tremendous competitive advantage since they will not only get zinc cheaply, but also hopefully won't have to stand in line to get zinc during a time of crisis! Perhaps this partly explains the upcoming disaster unfolding in the world wide zinc market. I call it a disaster because zinc prices should have risen higher, sooner, to affect all market participants equally, to help to most efficiently and appropriately ration (by price) the remaining zinc that we have left.

Instead, it seems that big companies that made stupid hedging mistakes are continuing to supply many zinc users with sub-economic, low priced zinc, which is not encouraging them to conserve. So, the drawdown of zinc inventories is continuing at an unsustainable pace, and it looks like we'll see either a terrible shortage of zinc, or an explosion of zinc prices.
The key flaw of communism is that when prices for goods are set below free market prices, shortages and misery are always the result. I just don't see how anyone can justify futures contracts as a part of the ideal free market. Futures contracts, by definition, lock you in and force you to perform, and are the exact opposite of freedom.
This analyst says: "I expect zinc to be selling over $2.50 a pound in 2007. After that, sky's the limit. With the right conditions I believe we could be looking at $5 or $6 zinc within a few short years."

Metalline Mining (MMG on the AMEX)

MMG is my number one stock position, over 10% of my portfolio. I own 400,000 shares of MMG, and 400,000 warrants at $1.25 good for 5 years. I can't sell this until the 1-year hold time expires, perhaps in late January, 2007.
MMG has about 50 million shares fully diluted, at a share price of $4, and is a market cap of nearly $200 million.
MMG has 5.8 billion pounds of zinc resources (More than Apex Silver), and is working on a feasibility study that may take another 1 - 1.5 years to finish. This zinc is all unhedged.

There is a great blog that covers MMG here:

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