This ‘Psychic’ Metal is Predicting a Christmas Rally

Wed, Nov 9, 2011 - 5:42am

They call it 'Dr Copper' - the metal with a PhD in economics - because of its forecasting ability.

It turned up in 2003 as the world recovered from the dotcom crash. It peaked in 2008, shortly before the stock market crash, and it rebounded in 2009.

Sounds great. But in fact, if you look at it, copper actually rises and falls with general market sentiment. It's more of a barometer than forecaster.

A far better forecaster would be a metal that moves before the event, a metal that peaks or troughs early – in late 2006, early 2007, say, or in 2010.

Such a metal exists. It's copper's less widely discussed, less glamorous industrial cousin: zinc.

So what can it tell us about today's market? And what's the best way to play it?

Zinc isn't glamorous or world-saving

Unlike uranium, rare earth metals, or even gold and silver, zinc is not a metal that is going to save the world. It's not the answer to looming energy, technical or monetary problems.

Its main use (over 50%) is in galvanising, to prevent rust. Zinc is very reactive, so a quick coat of zinc on your iron or steel will attract all the oxidisation and protect the metal beneath. It's also used extensively in alloys (brass and bronze in particular) and compounds. You'll find zinc in a huge range of applications, from communication equipment to coins to cars to piping to bearings to water valves.

It's widely used (only iron ore, copper and aluminium are more heavily used). But there's no huge deficit between global zinc supply and demand to get excited about – there's lots of it and when demand grows, production can be increased too.

Identified worldwide resources are estimated at just below the two billion tonne mark. The largest deposits are in Canada, the US, Australia and Iran. Annual global production stands at around 12 million tonnes, 70% of which comes from mining and 30% from recycling.

According to recent data made available to the International Lead and Zinc Study Group (ILZSG), world demand exceeded supply by 223,000 tonnes in 2011, in the year to date. World stock levels increased by 201,000 tonnes, although London Metal Exchange stockpiles (along with those of all base metals, interestingly) have been declining since the summer.

From the same data, we see world zinc production rose by 14.5%; apparent Chinese demand increased by 14.9% and world usage by 16.7%.

A history of the zinc price

As for the zinc price, it is trading in a fairly tight range. Its year high was just above $1.1/lb in February and its low, in October, was $0.80/lb.

Here we see a long-term chart of zinc since 1989.

It fell from about __spamspan_img_placeholder__.90/lb in the late '80s to __spamspan_img_placeholder__.40/lb in 1993, then spent the rest of the decade mired in a tight range between __spamspan_img_placeholder__.40 and __spamspan_img_placeholder__.55 or so, with one brief spike above that level.

After the dotcom crash, it sunk even below __spamspan_img_placeholder__.40/lb until 2003 when it began to creep up – in line with general market sentiment.

But then in 2004-5 it broke out above that multi-year __spamspan_img_placeholder__.50/lb or so cap and within two years quadrupled. In late 2006 it broke above /lb. Insane stuff. If ever there is a chart that reflects the bubble of credit and speculative excess the world got itself into in that period, it's this one.

Then the zinc price began falling – ahead of the markets – and quickly returned to __spamspan_img_placeholder__.50/lb break-out point, giving back all of the gains of the previous two or three years.

We then got the proverbial 'dead cat bounce', which petered out at .20 in 2010. We have been stuck in a range ever since, between there and __spamspan_img_placeholder__.80 on the downside. This month it has turned back up.

Professor Zinc's psychic powers

I would say Professor Zinc better reflects the real global state of things than the Dr Copper. In July 2008 copper was making new highs (with oil), when zinc had long-since turned down, and the credit crunch was in full flight.

In early 2011, copper made new highs again, above 2006 and 2007 levels – when the real economy was in a more parlous state. Here's a chart of copper over that period. To me, it is less a reflection of the economy and more a reflection of the speculative excess at the extreme end of finance.

So what is zinc telling us now?

It has turned up, and I see some buying coming back into the junior mining end of markets, so perhaps we can expect this rally to continue until Christmas and even into the New Year.

But there are plenty of problems lurking on the sidelines, as we all know, so I would be ready to jump ship should they rear their ugly heads again. And I'll be watching closely to see if the zinc price provides an early warning of the next downturn.

If you wanted to trade zinc, ETF Securities offers a zinc ETF (LSE: ZINC). But I can't see the point. I don't see huge price rises in zinc itself coming. The top large-cap zinc-producing companies include Xstrata, OZ Minerals, Teck Cominco and Glencore, all of which may be ripe for a rally to early next year.

However, the small-caps offer more growth potential. One suggestion for a small-cap, pure play on zinc is the former golden boy ZincOx resources (Aim: ZOX), a company whose management I like.

I should also mention Toronto Venture Exchange-listed Vena Resources (TSX: VEM), a company I have mentioned here before. It is bringing a zinc mine into production in Peru and, according to reports, it has made good progress. Vena has been hammered this year for two reasons.

First, there was a lot of (probably misplaced) risk perceived about the new Peruvian government being mining unfriendly. Second, Vena is also exploring large uranium deposits and the market fell horribly out of love with uranium after Fukushima. But below C__spamspan_img_placeholder__.20c Vena offers potential value and growth (I hold the stock myself).

My latest gold report is now available – as well as looking at ways to buy gold itself, I’ve also tipped some speculative mining stocks that I think are poised to do very well in the coming years, and provided some updates on my previous tips. Get your copy of my gold report here.

This article first appeared in Money Morning, the free daily investment email from UK investment magazine, Moneyweek. Sign up here - it's free.