“Fair Is Foul, and Foul Is Fair”: Why This Foul Metal Is Looking Fair

Eric Fry By Eric Fry, Macro Strategist, The Oxford Club

Metals

“Fair is foul, and foul is fair” is not simply a famous line from Shakespeare’s Macbeth… It is also a fitting description of the metals market in the last couple of years.

The “fair” metals like gold, silver and platinum have delivered foul investment results lately, while several of the “foul” base metals have shined bright like a fair summer day.

The divergence between precious metals and base metals is noteworthy but not particularly surprising. Demand for gold, silver and platinum has simply not been sufficient to raise prices.

Demand for select base metals, on the other hand, is robust and growing.

One of the fairest of the foul metals has been zinc, and its price seems likely to continue trending higher over the next couple of years.

Like a middle child in a 10-child family, zinc doesn’t receive a lot of attention day to day… at least not from investors. But its price has doubled over the last 18 months.

The explanation for this price gain is a classic supply-and-demand story. The former is struggling to keep pace with the latter. During the last four years, global zinc demand has grown nearly 14% – setting it on a collision course with insufficient supply.

The International Lead and Zinc Study Group projects zinc mine production to hit 13.7 million metric tons this year… which would be 223,000 metric tons shy of the demand forecast for the year. And Teck Resources (NYSE: TCK), a major zinc miner, expects “supply deficits” like these to persist for several more years.

Most of us pay little attention to zinc, but this metal is an essential part of our day-to-day lives. It is the world’s fourth most used metal behind iron, aluminum and copper.

Zinc combines with certain metals to make a wide variety of alloys. But its primary industrial use is to galvanize steel. Because of this relationship, zinc demand closely tracks global economic growth, especially the construction-intensive economic growth occuring in China…

But demand for zinc is also coming from a new sector: agriculture.

It turns out that huge portions of Earth’s arable lands are zinc-deficient – including very large portions of the arable land in the U.S. So by adding zinc to the soil as a micronutrient, crop yields can increase dramatically.

According to CropLife America, “Zinc deficiency is one of the most common micronutrient deficiency problems globally, especially in cereal grain crops, which comprise the dominant food source for much of the population in developing countries.

“Nearly 50% of cultivated soils worldwide currently contain low amounts of plant-available zinc.”

The good news is that adding zinc is very effective, which is why demand for zinc fertilizers is growing so rapidly.

Agricultural demand for zinc currently represents only 2% of total demand. That doesn’t seem like much until you realize that 2% of total demand equals half of this year’s supply deficit.

As an incremental influence in the market, agricultural demand for zinc could be very important. According to industry estimates, it could represent as much as 6% of total zinc demand by 2025.

So this wildcard demand from the agricultural sector could put even more upward pressure on zinc prices.

The robust global zinc demand is making its presence felt at the London Metal Exchange (LME). As the chart below shows, zinc inventories at LME have dropped to their lowest level since 2008, coinciding with rising zinc prices…

As you’ll notice in the chart, something similar happened between 2004 and 2006, when zinc inventories dropped sharply and the price quadrupled from $0.50 per pound to $2 per pound!

Perhaps we’re witnessing a repeat performance…

In an interview late last year, Teck Resources CEO Donald Lindsay called zinc the “most exciting commodity.”

“It has already gone through its bottoming process and is in a distinct [supply] deficit,” he said. “We think zinc is just on the verge of [a] big move.”

Since the day Lindsay issued his bullish forecast for zinc, LME inventories have tumbled another 40%. So the “big move” he anticipated could be drawing closer.

Unfortunately, investing in zinc is not particularly easy. The only “pure play” on the metal is a small London-based exchange-traded fund (ETF) called the ETFs Commodity Securities Limited Zinc (LSE: ZINC).

This ETF tracks the price of zinc. Here in the States, the closest thing to a pure play on zinc is not very pure. The PowerShares DB Base Metals ETF (NYSE: DBB) reflects the prices of three base metals: zinc, aluminum and copper.

Beyond these options, one could invest in a zinc mining stock. But again, pure plays are hard to come by because the large cap zinc mining companies also produce other metals and/or natural resource products.

That said, Teck Resources has a large and growing exposure to zinc. In its most recent earnings report, the company’s zinc operations produced about one-third of net profits.

According to Lindsay, every $0.01 increase in the price of zinc boosts Teck’s EBITDA (earnings before interest, taxes, depreciation and amortization) by $14 million, all else being equal.

A 1% impact may not seem like much… until you start imagining a scenario like this one…

If the zinc price were to climb back to its 2006 high of $2.11 per pound, Teck’s EBITDA would nearly double, all else being equal.

So keep your eyes on zinc. This foul metal is becoming quite fair.

Good investing,

Eric


Managing Editor’s Note: As you probably imagine after reading this article, Eric is an expert when it comes to commodities and macroeconomic trends. The kind of insight you’re seeing here is what helped him beat Wall Street’s best traders in the prestigious Portfolios with Purpose contest…

It’s also helping him deliver incredible gains to his Fry’s Pinnacle Portfolio subscribers. To learn more about his groundbreaking research service, click here.