We’ve seen impressive run-ups for many commodities over the past year-uranium, copper, gold and even less-followed metals such as lead have all seen double-digit percentage growth in price. For those currently looking to get into the market, however, these gains beg the question: how much upside is left for these metals? Are there any investments that still have potential for big movements during the coming year?

One candidate may be zinc, a metal that draws more than half its consumption from the booming steel industry. Looking at the numbers for 2004 as a whole, the metal appears to be an underperformer; its price, although moving up, lagged the other base metals, gaining only 25 percent as compared to 40 and 41 percent gains for copper and lead, respectively. But the slow start may have left zinc with more room to grow than the other metals. Indeed, a closer look at the data, isolating the last half of 2004, reveals that the zinc price gained 32 percent during that time, as opposed to only 21 and 19 percent for copper and lead.

Why the slow start and late acceleration? According to a recent research report from base metals major Teck Cominco, a big part of the explanation is that the zinc market has been burning through a significant oversupply for much of the current decade. In 1999, zinc stocks on the London Metal Exchange had declined to near decade lows, leading to a 33 percent rise in price during the year, from $0.42/lb to $0.56/lb. The upswing proved short-lived, however, when zinc producers around the world responded by increasing production by 720,000 tonnes, or 12 percent, through 2001. Zinc consumption, by contrast, rose only 86,000 tonnes. The considerable surplus of metal went into stockpiles, primarily on the LME. Because of the build-up, the price promptly plummeted throughout 2001 to $0.36/lb.

Of course, with zinc prices depressed, producers scaled back or went out of business completely. From 2001 to 2003, increased production was only about one-tenth the growth of the previous three years, at 88,000 tonnes. In fact, in 2002 mine output of zinc declined to the point where supply to zinc refiners was actually in deficit. The price, however, stayed depressed as refineries drew on their sizable stockpiles to meet the shortfall rather than purchasing zinc on the market. According to Teck Cominco data, refineries used 400,000 tonnes of stockpiled zinc in 2002 and a further 250,000 tonnes in 2003.

The result being that by 2004 (some analysts suspect), refinery surpluses were exhausted, forcing refiners to once again buy mine supply. The price therefore began to rise. Another factor aided the jump: China. As with other commodities such as coal, China, in 2001, went from being a net exporter of zinc to being a 300,000-tonne annual importer. This was partly due to rising Chinese consumption, which was increasing by 125,000 tonnes yearly. Increased imports were also needed by the Chinese after a number of serious mining accidents in August 2000 forced the shut-down of several zinc operations in the Nandan Province.

Despite these factors, the zinc price was sluggish in the beginning of 2004 compared to other base metals, rising to $0.50/lb in the first quarter and then actually declining to $0.43/lb through to September. Why? We believe it was due to something called the “hidden stock phenomenon”. During 2002 and 2003, Teck Cominco estimates that some 517,000 tonnes of zinc entered the market, and yet official stockpiles such as those of the LME only increased by 245,000 tonnes. It’s thought that the missing 272,000 tonnes were delivered to warehouses but not reported, simply being held by buyers.

That changed when the zinc price rose in late 2003 and early 2004. The higher price prompted owners of hidden stockpiles to sell some 347,000 tonnes of metal into the market between November 2003 and September 2004, keeping the price low. Teck Cominco believes, however, that hidden stockpiles were probably exhausted by the last quarter 2004, with official stockpiles subsequently falling by 107,000 tonnes by the end of the year, and down 15.7 percent by January 2005. With supply drying up, the price jumped to $0.55/lb in the beginning of 2005, reaching as high as $0.645/lb early in March.

Will the gains stick? Most indications seem positive, at least for a few years. Analysts including Societe Generale, Barclays and the International Lead and Zinc Study Group agree that the market was in deficit in 2004 somewhere between 200,000 and 320,000 tonnes of zinc. The same groups predict a shortfall of around 200,000 tonnes in 2005. After that, forecasts get hazier, with some analysts expecting a continued deficit and some predicting the market will move into surplus. Teck Cominco feels, however, that increases in mine output in response to the current high prices will not reach the levels that swamped the market in 1999-2001. At that time, production grew by over 700,000 tonnes in three years. This time around, the company sees only a 261,000 tonne increase in output for the period 2003-05.

Of course, there are X-factors that could result in unexpected price falls. As is the case for many commodities, industrial growth in the US and, particularly, China is key in driving demand for galvanized steel and therefore zinc. In the case of China, one development that may negatively impact the global zinc price is renewed central trading of the metal in Shanghai. According to a Platt’s Metals Week article late last year, four of China’s major zinc producers are considering resuming trade of zinc on the Shanghai Metal Exchange. The four companies were also reportedly considering pooled buying to achieve better prices, which could spur domestic production. However, Chinese mine production of zinc has reportedly been limited by depleting reserves, while smelter output has been limited by power shortages at facilities (such as the Zhuzhou smelter, which was forced to shut down in January), factors tending to push China in the direction of importing more.

Despite such positive developments for the zinc market, there is caution amongst both analysts and producers going forward, given the volatile price history of the metal. Last December, a Macquarie research report noted that, despite an optimistic price outlook, zinc is a “perennial dasher of hopes” and that “years of underperformance leave us cautious of getting too bullish at current levels.” At a meeting of the American Zinc Association in early March, Greig Gailey, CEO of Australian zinc producer Zinifex, owner of the Century mine in Queensland, the world’s second largest zinc producer, warned that zinc’s current bull market could be “destroyed by overinvestment in new capacity” on the part of miners and refiners. For his part, Gailey said that he sees high zinc prices sticking for three to five years.

The same conference heard similar warnings from a CRU analyst, who warned, “The low prices seen in 2000 closed many mines or put them on a care-and-maintenance basis. These can be taken back on stream.” CRU, in fact, sees zinc reaching a 240,000 tonne surplus by 2008, at which point it will take “ten years for profit to recover.” One such mothballed project that could have a major impact on zinc prices is the Lennard Shelf mine complex in western Australia. The operation, formerly owned by Western Metals, produced 176,000 tonnes of zinc in the year ended June 30, 2003, just before it was shut down. In other words, Lennard’s output alone would make up the lion’s share of the zinc market’s current deficit. Lennard Shelf has since been bought by Teck Cominco, which reports that the complex’s potential annual capacity is as high as 3.1 million tonnes.

However, some producers may be getting out of the zinc market, even as prices rise. Late in March, Anglo-American subsidiary Kumba Resources announced that they are considering moving away from zinc because of the metal’s unstable fundamentals. Kumba’s executive director Richard Wadley told Business Day that despite the “great buoyancy in the zinc market” of late, “historically it has been very volatile.” The company currently owns an 89.5 percent stake in the Rosh Pinah mine in southern Namibia, which produces 120,000 tons of zinc annually.

The overall sense in the industry seems to be, however, that if zinc producers take a measured approach to upping production, there could be room for at least a few years of profit as supply looks to remain tight in the absence of significant new supplies. At least one leading mining group appears to be betting on it; Lundin Mining, run by the highly successful Adolph and Lukas Lundin, recently acquired Irish zinc miner Arcon International, owner of the Galmoy mine, which hosts some 4 million tonnes of zinc ore. Lundin will now reportedly produce 152,000 tonnes of zinc annually. The company could present an interesting investment if zinc does indeed see a few years of supply deficit and concomitantly high prices.