smc wealth - lead... delicately poised for record highs

8/14/2019 SMC Wealth - Lead... Delicately Poised for Record Highs

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LeadLeadLeadDelicately Poised

for Record highs

Delicately Poised

for Record highs



Contents

Section 1

Executive Summary 1

Section 2

Lead 2

Prices are running ahead of fundamentals

· Recent price trend· Falling treatment charges· China stimulus package· Lead Warehouse stocks· Lead spread scenario

Section 4

Our base case scenario for prices 6

Section 3

An exceptional recipe 5· Demand· Supply



Executive Summary

A selective bull market from hereIn the bull market across industrial commodities (and morerecently the soft commodities), the role of the individualfundamentals can sometimes get “lost”. However, they havebeen critically important in determining the relativeperformance of the individual metals.

The LME party remained in full swing since the start of thismarch with new 2009 highs and strong weekly closes across allthe major nonferrous contracts. Copper and Lead are alreadypretty far-gone and need no extra encouragement. The music isgetting louder as long as it's got the words "green" and "shoots"

in the lyrics. Green Shoots Yes, Recovery Not Yet. It's not justthe LME complex that's partying, of course. Stock markets,which the metals have been following slavishly, are also inebullient mood as the financial world convinces itself that the"green shoots" of economic recovery, first mentioned by BenBernanke back in March, are now sprouting in profusion.

Base Metals have outperformed both the wider complex andequities since the start of March whilst the LMEX index(representing all 6 LME base metals) is up almost 50 percentsince March. More over, the overall price performance, detailedin the table, was itself ambiguous enough to encourage both

bulls and bears. The former will talk of a much-needed period of consolidation after the strong rallies of April, May and earlyJune. The latter will greet the stalling of the up trend as a signthat markets are now due for a major correction lower after over-extending themselves on the upside.

The recent experience of pricing the Copper market highlightshow there can be a strong rally in the price on back of smallimprovement in fundamentals and availability of the disposableliquidity created by inflation expectations. The market haschosen to focus on strong rebound in risk appetite, which alsoled this excess money flowing into the most promising assets.

Lead is so far leading the LME price rally surpassing theflagship metal, which also gets support from reports - printingimprovement in the economic health, apart from metal specificfundamentals. Many funds will continue to chase this Batterymetal, which is supported by – sustainable demand from thebattery sector and a decline in lead treatment charges alongwith more mines to be closed as a result of lower prices of Zincas Lead holds a by-product status of it.

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Our Base Scenario for Prices

Lead demand will continue to gain momentum as investors seem to be concluding that we could be in the final throes of the recession.

With the tailwind of a weaker dollar and trillions of dollars on the sidelines that could conceivably flow back into the financial markets, asharp upside bias could be in place going into the summer months. More over, from micro viewpoint, critically low LME warehouse stocks,seasonal demand from recession-resistant replacement battery sector, physical tightness of metal in spot due to production cuts by Zincmines and additional supply disruptions such as La Oroya and Glencore are making the best possible fundamentals for this metal. Our base case forecast is $2500/tonne in 2009 and $4000/tonne in 2010.

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Metal Index Performance

Source: Reuters, SMC Wealth

Source: Reuters, SMC Wealth

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Lead

Prices are running ahead of fundamentalsThe outlook for Lead from a fundamental point of view looksrelatively bright in comparison to some of the other base metals.Although demand from the metal industry has suffered from thedownturn in economic conditions, it has held up better that thatof the other base metals preliminary due to the robustness of replacement battery demand over the winter months.

Lead has some intrinsic resilience to the economic cyclebecause around 40 percent of demand comes fromreplacement batteries. A dead car battery is not a luxuryconsumer item. It is a necessity for even the most cash-

strapped car owner. But it is no means completely immune tothe wider manufacturing picture, particularly when it comes tonew car batteries.

The finely balanced market and upcoming summer demandseason in the northern hemisphere, Lead prices have caughtthe attraction of my fund houses, which can also be seen in theprices since the start of current rally. Lead prices have movedvery sharply but there are few developments that are still left totake place in the Lead market like increase in the physicalpremiums at major spot markets and sustain draw downs in itsLME inventory. But these factors are just a matter of time and

with approaching demand season, we believe it won't be latewhen market takes these things into consideration which willfurther fuel the price rally.

Lead prices should pause at current levels after making fresh2009 highs before resuming it's another leg of bull-run.

Recent Price Trend

There was a time when Lead was the cheapest base metal onthe LME complex. With a toxic reputation and dying end-usemarket (except batteries market), very few wanted to know

Lead and even fewer wanted to mine it. It is largely the reasonwhy lead prices are quoted more than Aluminium and Zincprices, which is also a historical shift in the metal pricing.

Lead is one of the few markets where any minor changes to thefundamentals could trigger off significant changes in prices.This was demonstrated by Lead's extremely volatile October month of 2007 when it peaked at $3890.15/tonne. This pricesrally has been ignited by the suspension of Ivernia's Magellanmine which was banned from exporting 3 percent of theenvironmental concerns.

However, prices have witnessed the hemorrhage of the

financial crisis in which it traded below $800/tonne in December last year. Since then, prices have consolidated which laid astrong foundation for the recent price rally. This rally has alsobeen mirrored across the base metal complex, due to optimismregarding the future economic outlook.

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Lead Zinc Aluminium

Lead is priced more than its peers

Source: Bloomberg, SMC Wealth

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Forward Curve

US $ per tonnes

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LME forward curve of Lead clearly indicates that investors arepaying huge premiums for the up coming months as comparedto the far months of next year and year after that. The steep risein this curve also supports our view that in coming timeavailability of the metal would be scare due to tight marketbalance and strong rebound in demand from major consumingeconomies.

Falling treatment charges will further tighten thesupplies.

The smelters collect TC/RC fees from mines for Treatment andRefining of the concentrates. This charge increases when there

is plenty of metal concentrate available for smelting, as thesmelting capacity is limited.

This scenario is worse in China which is world's top leadproducing country. TCs (Treatment Charges) are paid byoverseas sellers to Chinese smelters for treating imports, andthen are deducted from sale prices, based on LME Lead. TChave fallen 90 percent this year to only $10/tonne to China,making spot imports for the smelters more expensive. Moreover, a 60 percent rise in contract prices of the London MetalExchange Lead has also added on the cost. Chinese smeltersare not willing to import much of the metal as TCs are low and

lead prices are high. TCs were at $200 in early December and$100 later around January month. Many smelters are alsoswitching into low-silver concentrates because silver prices aretoo high which makes the concentrates even more expensive.Reduced supply of imports could force smelters in China to cutproduction in the second half of the year given supply of locallyproduced concentrates was unlikely to surge if prices stayedbelow 15,000 Yuan per tonne, (which are almost more than 20percent more than last week's prices in Shanghai) as majority of low grade mine in China were making losses. Mines located inthe northern provinces of China are still closed from their winter break. Tight concentrate supplies and upcoming summer

maintenance will continue to affect the metal production in theonset of H2 as well. This will further arrest Chinese Leadexports to just around 400 tonnes per month which havealready fallen by 93 percent on the year. A gradual shift is alsowitnessed in China's Lead trade as it is losing its status of a netexporter to a net importer. (1$ = ~6.835 Yuan)

We expect the above stated reason to get echoed in pressreleases, which will also escort to an impending major changein the metal fundamentals.

China Stimulus will have spill over effect on Lead prices.

The breakdown of how the Chinese government has allocatedthe 230 billion Yuan it has spent so far as part of the country's4 trillion Yuan ($585 billion) stimulus package has given us

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more optimism on the outlook of Zinc and Lead prices. Amongstthe allocated fund, construction of 20000 kilometers of ruralroads and completion of 445 kilometers of expressway will helpincrease in battery demand from car and E-bikes (electric bike).

As more roads are built in the countryside, E-bike demand willcontinue to grow at an improved rate due to its affordability. Aquarter of Lead consumption in China is used in E-bikes.

Economic stimulus has also helped in jumpstarting automobilesales in China. Higher vehicle sales will also be responsible for driving up second-half demand for lead in China. China, whichovertook the United States as the world's No. 1 auto market inJanuary, has continuously posting car sales growth above 20percent for three years in a row. Car sales in the month of May

rose 47 percent from a year earlier to 829,100 units, as Beijing'spolicy incentives which included halving of sales tax on cars witha 1.6 liter engine or smaller and rebates for buyers in rural areas.Where as total vehicle sales were up by 34 percent at 1.12 millionunits. Similar performance of 37 percent for passenger cars wasprinted in the month of April. This number will continue to impressnot only because of the incentives but because of lower baseeffect as well but ultimately it will improve sentiments andoptimism of better demand for the battery metal.

By the end of last year, China had 170 million vehicles and 80million electric bicycles. These figures are expected to improve

by around 20 percent due to stimulus packages and other incentives. A Battery for a passenger car uses about 9 kg of lead,while that for a truck requires 12 kilos. Electric bike batteries useabout 7.5 kg of lead.

LME warehouse stock at historical lows

Lead remains the only stellar price performers in the LMEindustrial metals complex so far this year after Copper. The heavymetal is marginally outperforming the red metal on back of thesame positive macro-economic drivers impacting the entiremetals complex, both metals have benefited from strong import

1987 20071989 1991 1993 1995 1997 1999 2001 2003 2005 2009

LME Lead stocks & price comparison


'000 tonnes US $ per tonne



demand from China. However, there is one very strikingdifference. While LME-registered stocks of copper have beentrending strongly lower, those of lead have been trendingstrongly higher. Lead stocks at above 82000 tonnes are almost80 percent more since the start of 2009. Moreover, these trendslook set to continue, in the short term at least as there is aminimal at less that 0.5 percent cancelled Lead tonnagesuggesting flows of the metal will remain skewed towardsarrivals.

At the start of this year LME lead stocks represented just 2 days'worth of global consumption and now they are around 3.5 daysof consumption, which is still critically low as compared to itshistorical averages. Moreover, this highly limited rebuild has

come at a time of near-global manufacturing recession anddepressed demand for all industrial metals. Apart form lead allother metals have witnessed massive inflows into the LMEwarehouses in past 12 months. Lead has some intrinsicresilience to the economic cycle because around 40 percent of demand comes from replacement batteries.

When investigating the stock movement of this metal, the metalis only available in the European and American warehouses of LME. Asian and Middle East locations are already running dry of metal. We further found that Detroit (US location) representsthe single largest concentration of warranted lead in the LME

system with 17,450 tonnes in exchange warehouses. This is notany coincidence give vehicle production slashed, or haltedaltogether in the case of Chyrsler. More over, Lead stocks alsorise in the initial quarters of the year and then it tends to befollowed by strong inventory draws over the northernhemisphere summer months of June to August. This is whenthe holiday "driving season" in both North America and Europesets in, meaning more battery failure and a summer boost to thereplacement battery sector. This marked seasonality in leadinventory runs counter to other industrial metals, wheredemand is impacted by the summer holidays, which againmakes Lead prices more tempting to the funds.

LME spread the best leading indicator for price direction

The sharp recovery in the global market has still left manycontradicting the “signs”. Global market sentiment continues togyrate between cautious optimism that the worst is truly over and a nagging fear that it might not be. Going ahead the LMEmetals will have a very selective price rallies which will focusmore on metal specific fundamentals rather than just sheer exuberance which was actually "too fast and too furious". Thethree-month price charts for all the big LME contracts show

sharp gains in every parts of the previous weeks'. But the realaction right now is in the less charted territory of LME spreads.

A dominant long position has become a daily feature in the leadmarket. The pressure on nearby dates abated over the course

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Lead prices & spread


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of last week, the cash-to-three-months period finally returning

to $24 contango on Friday, partly thanks to a hefty inflow at LMEwarehouses which are up by around 80 percent since the startof this year, but that does not promise much in the way of arebuild in LME stocks, which remain at distress levels at aroundthree and a half days' worth of global consumption. However,the Lead spreads still look dangerous and especially after theassessment by the International Lead and Zinc Study Groupthat the global lead market will record only a marginal 37,000-tonne surplus this year, global manufacturing recessionnotwithstanding.

Lead spread will also be affected from seasonal summer battery demand and any supply side disruption news. Our pastexperience has made us aware of the fact that a metal with astructural backwardation attracts more funds and becomesmore appealing for investors. Therefore the nearby spreadstructure of this metal is worth paying close attention to in thecoming days and weeks.

Another GM in the making amongst the US Leadproducers.

Doe Run is the largest US Lead producer, which has halted alloperations at its La Oroya smelter earlier this week because

financial and environmental setbacks have prevented it frombuying concentrates.

Doe Run Peru, the country's fourth-largest metals exporter,generates some 3,500 direct jobs and 16,000 indirect jobs.Operations at the smelter, hobbled by financial woes, havebeen off and on since March, after banks cut credit over worriesabout falling metals prices. Without financing, the companycould not consistently buy concentrates. More over, the currentdeadline on the cleanup at La Oroya, which frequently ranks asone of the world's top 10 most polluted places, is October. Thecompany has said meeting that deadline will be "difficult" and

has asked the government to give it more time. The miningministry has so far said it is not willing to extend the deadline.Last year La Oroya refined around 119015 tonnes of Lead andwith the ongoing concern it is expect to only refine around33780 tonnes of Lead.

Lead market is already running in tight balance of demand andsupply and in this scenario, such events will be enough for thesensitive market to overreact resulting in serious rise in themetal price.

An exceptional recipe – Higher Demand & Lower Supplies.

The peculiarity of the current surge in prices is skewed towardsthe improving optimism and economic fundamentals

suggesting growth prospects amidst sharp recovery. But going

ahead, metal specific fundamentals will not only help them tomaintain their recent gains but it will also responsible for decidingfurther price direction.

Demand

International Lead and Zinc study group (ILZSG), is consideredto be the market benchmark for Lead and Zinc analysis. As per their estimates, global Lead consumption was down marginallyby 1 percent over the first quarter to 2.007m tonnes. Significantdeclined were observed in the European and American

continents by 17 percent and 10 percent respectively. But thisdecline in growth was very much substituted from China as itrecorded 28 percent growth.

Car buyers in China are battling with an unexpectedconsequence - - two-month waiting lists due to China's auto-stimulus package which is discussed elsewhere in this report.

Automobile demand outside China is also showing glimmers of hopes. US, which is the second largest vehicle market after China has reported a pick up in their vehicle sales. This salesprinted 9.9m units in May to record its highest levels in this year.Similar strong numbers were printed in March and April saleswhich stood around 9.8m and 9.3m units respectively. The mainreason for higher demand is aggressive discounting by car makers.

More over, last's year's enigma has been resolved this year in theLead market as China will finally switch from being a net exporter to a net importer of refined Lead. In 2007 it exported a net of 211000 tonnes of metal and in 2008 a net of 2700 tonnes. In thefirst quarter of 2009 it imported 48320 tonnes of metal which is up826 percent year-on-year. This paradigm shift has also helped inabsorbing excess metal surplus in the times of manufacturingcontraction in the western economies. Chinese demand is rather a combination of an export tax on Lead and regional state support

for domestic metal producers due to sharp fall in metal price.Lead stocks are also very limited in the LME warehouses (as itcan only satisfy 3.5 days of global consumption) and with peakdemand season looming, the Lead market could be in for a veryhot summer.

Supply

Lead's supply side is equally contrast as its strong demand side.The ILZSG's forecast assumes a 0.9 percent decline in refinedmetal output this year and a 6.3 percent decline in mined output.

More over, despite sharp run-up in Lead prices so far, there will beno rush to the mothballed mine capacity, largely because Leadtends to be a by-product of Zinc mine production. Many Zincminers had cut their mining capacity, whereas many smaller



smelters have been forced out of business by the dramaticprice collapse of late in 2008.

Production cuts and project delays at the biggest miningcompanies, including BHP Billiton Ltd. and Xstrata Plc, maylead to a shortage of metal supply not seen since a record rallybegan in 2003. Supply growth will even more constrained nowthan during the last five-year boom. The delayed projects willalso wait for further clarifications of price outlook before takingany premature decisions. Here again, any supply response willbe restricted in the short term by the fact that Lead output tendsto be a by-product of Zinc operations.

Refined metal output has also been affected recently inAmericas-Peru, where production fell 25.8 percent over thequarter to 23,000 tonnes. This is in part due to significant andongoing problems at Doe Run Peru's La Oroya smelter wherethe situation has worsened. In Europe, Glencore has places its80,000 tpy Lead production line at Portovesme in Sardinia ontemporary care and maintenance. It is believed that theoperation may remain closed until early August to allow for maintenance work to be completed.

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Our base case scenario for prices

Lead demand will continue to gain momentum as investors seem to be concluding that we could be in the final throes of the recession.With the tailwind of a weaker dollar and trillions of dollars on the sidelines that could conceivably flow back into the financial markets, asharp upside bias could be in place going into the summer months. From micro viewpoint, critically low LME warehouse stocks, seasonal

demand from recession-resistant replacement battery sector, physical tightness of metal in spot due to production cuts by Zinc mines andadditional supply disruptions such as La Oroya and Glencore are making the best possible fundamentals for this metal. Our base caseforecast is $2500/tonne in 2009 and $4000/tonne in 2010.

Mine Apporx Output LossHellyer Cons, Australia 7,000t

McArthur River, Australia 7,000t

Rasp, Australia 15,000t

Potosi, Australia 9,000t

Handler Hill, Australia 15,000t

Caribou/Restigouche, Canada 20,000t

Black Angel, Greenland 6,000t

Galomy, Ireland 9,000t

Rosaura, Peru 20,000tParagshu, Peru 18,000t

Iscaycruz, Peru 10,000t

Aljustrel, Portugal 17,000t

Missouri mines, USA 40,000t

Total Approx 193,000t

Lead production cuts in 2009

Source: ILZSG, SMC Wealth

Source: ILZSG, SMC Wealth Source: ILZSG, SMC Wealth

World Lead output forecast World Lead mine forecast



2005 2006 2007 2008 2009

China 1973 2179 2600 3000 3200

US 1586 1622 1512 1525 1480

Germany 407 387 380 380 365

Other Europe 535 515 538 487 476

Other Asia 885 928 924 885 911

Rest of the World 2424 2415 2301 2245 2216

Total 7810 8046 8255 8522 8648

Lead consumption

2005 2006 2007 2008 2009

China 2391 2715 2757 3030 3200

US 1293 1303 1305 1330 1295

Germany 418 379 405 380 385

Other Europe 771 795 820 899 899

Other Asia 565 617 672 705 718

Rest of the World 2202 2152 2181 2214 2209

Total 7640 7961 8140 8558 8706

Lead Production(000 tonnes) (000 tonnes)

Source: ILZSG, GFMS Metals Consulting and SMC Wealth Source: ILZSG, GFMS Metals Consulting and SMC Wealth

Tejas Seth - Sr. Research [email protected]

Analyst



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