Zinc is hot. Everybody is talking
about it and buying anything related to it. My interest in
the “Great Protector” was piqued about three years
ago by the great Jim Rogers who mentioned it in interview
as a laggard in the metals cycle. With zinc being the best
metal performer in 2005 it looks like Jim is right again.
But how sustainable is the current strength in zinc prices?
Let’s start by looking at the inflation
adjusted price of zinc. In the early 70’s zinc reached
an inflation adjusted price of $10,000 per tonne. At the beginning
of 2006, the zinc price is still under $2500 per tonne. This
historically low price is less than one quarter of zinc’s
inflation adjusted high. If the commodity super-cycle plays
out, the ultimate price of zinc could be stunning, perhaps
far surpassing the high water mark of $10,000 per tonne.
Source: The Chart Store http://www.thechartstore.com
This technical fact is supported by the long-term fundamentals
of the zinc market. Take a look below at this graphic created
by Teck-Cominco showing current and future mine supply versus
expected demand. This graphic illustrates what is termed the
“Zinc Supply Gap”.
It is apparent that years of underinvestment
have left few projects in the pipeline. In fact, many producing
mines are set to close over the next few years. It is worth
noting that in the past, Teck-Cominco purposely choose to
not develop any of it’s zinc deposits so it would not
undercut the viability of its’ massive Red Dog zinc
mine.
Not only are there not enough projects in the
pipeline to meet demand. The economics of planned projects
continue to degrade. Oil, electricity, even giant tires for
mining trucks are all in short supply. More critically, experienced
geologists and miners are an aging group and tough to find.
To top it off, mining regulations are more rigid than ever
before with stringent environmental and aboriginal concerns
pushing out development timelines even further.
On the demand side, Asia is the key player,
with their hyper-growth expected to drive demand in the zinc
market. In fact, growth is now expected to be closer to 4%
per year, rather than the 1.5% or 2.5% currently modeled.
Zinc has few substitutes and could easily take
out its’ old highs without too much dislocation in the
economy. It contributes only a small portion of the end cost
for the products it is used in. For example, the average car
uses about 17 pounds of zinc. At ten times today prices zinc
would only add an extra $170 dollars to the cost of a car.
A slowdown in the U.S. is always a factor when
considering base metal prices, but America uses only about
11% of the world’s zinc. Furthermore, World population
is growing at an exponential rate, creating more people thirsting
for their first taste of Western living standards. North America
and it’s housing market could affect base metals prices
in the short term, but the future will see Asian economies
much less dependent on exports. The ramifications of this
inflection point will go far beyond base metal demand, but
that is beyond our scope here.
Currently there are a lot questionable valuations
for mining companies and zinc miners are no exception. I would
look for a quality senior and mid-tier producer along with
juniors with proven management and decent land packages. With
the price of zinc rising, these companies should do well over
time.
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