Zinc investors face a rosy future - Gallucci
As the large zinc mines shut down, zinc juniors are stepping forward to meet growing demand for the industrial staple, argues Joseph Gallucci of Dundee Capital Markets. An interview with The Mining Report.
Author: Peter Byrne
Posted: Wednesday , 08 Jan 2014 PETALUMA, CA (THE MINING REPORT) -
The Mining Report: How are the fundamental challenges facing the global base metals markets likely to play out in 2014?
Joseph Gallucci: There are several long-term issues that impacted copper and the other base metal spaces in 2013, and those long-term issues will persist for the foreseeable future. Allow me to explain the basics via a few examples:
Indonesia recently stopped the export of intermediary products, such as pig iron nickel. The country's leadership is increasingly practicing resource nationalism by restricting mining firms to in-house processing and to shipping only finished products.
In terms of supply chain disruptions in 2013, Grasberg and Bingham Canyon were two of the biggest issues, but we are still well below the annual average of a 5% supply disruption. This year has been an anomaly and quite low in that regard. Supply chain disruptions will definitely pick up going forward and they are impossible to predict.
For problems with mining infrastructure, Chile was the hot button. It has port access and infrastructure issues, and there are still no power agreements in place for many of Chile's mining development projects. These types of long-term issues will continue to impact the base metals sector into the future.
TMR: Were declining ore grades an issue in 2013?
JG: The decline of ore grade is a long-term problem. We are now seeing projects with only 0.3% and 0.4% copper being developed. Those are very low-grade ore bodies in massive open pits. The issue going forward is the grades will continue to fall unless there are stellar discoveries—which is certainly possible.
TMR: Given declining grades, is there an exploitable synergy between mining for base metals alongside precious metals in terms of lowering overall costs of production?
JG: It depends upon the nature of the ore body. Unfortunately, the declining grades are not strictly limited to copper. There is a decline across all of the base metals and precious metals. The grades just keep sinking lower and lower. But if a firm is mining a polymetallic ore body and it can make a concentrate, the mining and the processing activities are very similar for polymetallic ore bodies. On the other hand, if a firm is purely focused on producing gold doré bars, there are no synergies with the base metals on the processing side.
TMR: Let's look at zinc, which is a metal market that you have studied extensively. What are the commercial applications of zinc?
JG: About 50% of the zinc market is used for galvanizing steel as anti-rust protection for car manufacturing and construction. The biggest buyers are China at 45% and Europe at 20%.
TMR: What's the global supply situation?
JG: The market in the Western world has been in a supply deficit for quite some time, and now, for the first time, it is in a global deficit. And the deficit will only get bigger. The zinc market is quite different from the copper market because about 40% of its production comes from junior miners, whereas in the copper space, juniors only account for about 7% of production. As the big zinc ore bodies are tapped out and the large mines close, they will continue to be replaced by smaller zinc operations. Brunswick was the first to close, and Century, Skorpion and a whole host of other mines are following suit.
TMR: Are companies hoarding zinc in anticipation of higher prices?
JG: Hoarding is definitely an issue. For example, the zinc inventories on the London Metal Exchange (LME) are controlled by four big players. The bulk of their inventory is stored in several warehouse facilities in New Orleans. The metal stores are not readily available for distribution and it is in fact due to the multiple locations that warehousing companies can move product among themselves in an effort to keep queues long. Therefore, queuing issues can cause price increases—although it is hard to calculate the extent of the problem at present.
TMR: You have talked about the large zinc mines shutting down, which should drive up prices. Can you expand on that scenario?
JG: The big zinc ore bodies are near an end and there is no replacement on the horizon for two reasons: 1) There are no more big ore bodies available. 2) There is no serious exploration for zinc. The copper business faces the same dynamic of gradual diminishment of raw material. Interestingly, as Brunswick and Century and Skorpion shut down their zinc operations, the sector has been freed up to bring on smaller-capacity mines, which helps the supply situation. And there is undeveloped supply capacity in China. But none of these potential developments can replace the magnitude of what we are losing by way of the big ore bodies going extinct.
TMR: Does the downward trend in terms of supply mean that the zinc market is not cyclical?
JG: All commodity markets have long-term cycles. But right now we are dealing with a special zone of the long-term zinc cycle as the big ore bodies close one after the other and are not replaced. This is a first for the zinc market, even though it was not unforeseen.
TMR: So what features can make the changing zinc market attractive to investors?
JG: Zinc equities are leveraged to the commodity, and there are not many equities left to buy on the TSX. But it is important to look at the zinc cost curve, which is very flat compared to the copper cost curve. As the zinc mine shutdowns cause supply limitations, and warehouse inventories start to peter out, market prices will have to rise. And due to the cost curve, even a small increase in the price of zinc will generate a big increase in revenue for producers.
TMR: Will we see higher zinc prices in the near term?
JG: The price of zinc should respond positively as more shutdowns are announced. The fundamentals are clearly in place for both the zinc price and the equity prices that are leveraged to zinc to increase. The stock price of companies that are already in production will increase the fastest, but the others should quickly follow suit.
TMR: Is there some kind of technology that can replace the industrial use of zinc?
JG: Not unless you figure out a way to eliminate rust! Galvanizing is always going to be needed, and there is no cost-effective replacement for it as far as I know. If cars and buildings were suddenly made out of plastic, the need for zinc would fall. But short of total plastification, zinc is here to stay.
TMR: Thank you, Joseph, for being with us today.
JG: Thank you, a pleasure.
Joseph Gallucci has approximately 10 years experience in equity research. He joined Dundee Capital Markets in June 2012 as a senior mining research analyst. Gallucci spent the previous five years at Canada's largest independent broker, in the mining research team where he was originally a research associate and then promoted to Mining Analyst. Gallucci's main focus is on base metals and bulk commodities on a global scale. Prior to this, he was a research associate in the forestry sector at a Canadian bank-owned broker. Gallucci holds a Bachelor of Commerce degree from Concordia University and an Master of Business Administration in investment management from the Goodman Institute of Investment Management.