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LONDON: Is zinc going to be the next nickel? Even as the London Metal Exchange (LME) tries to reassemble the pieces of its broken nickel contract, there are signs that zinc could be the next metal market to find itself in turmoil.

A raid on LME zinc stocks has seen available tonnage fall to two-year lows. Traders are tapping the market of last resort for metal to ship to Europe, where smelting capacity has been idled by high energy prices.

The effect is to tighten LME time-spreads and keep the outright price pushing higher. Last trading at $4,320 per tonne LME three-month metal is sitting just below a potential options black hole.

There’s a strong sense of deja-vu with both the LME copper market, which had to be restrained last October, and the nickel contract, which had to be suspended in March.

PERFECT BULL STORM Almost 60,000 tonnes of LME zinc stocks have been cancelled in preparation for physical load-out since the start of the month. Singapore was raided to the tune of 40,000 tonnes with the balance split between Baltimore and New Orleans.

Total LME stocks look healthy at 123,675 tonnes, but the amount of zinc available for the physical reconciliation of contracts has slumped to 45,925 tonnes, the lowest since February 2020.

The exchange’s European warehouses hold a paltry 500 tonnes - all at the Spanish port of Bilbao - attesting to the squeeze on Europe’s physical supply chain caused by the loss of regional smelter production.

European zinc premiums are at record highs and rising, according to Fastmarkets, which has just lifted its North European assessment by another $10 to $440-500 per tonne over the LME cash price.

It’s no surprise that Trafigura, which operates three European zinc smelters, and others should be tapping the market of last resort to plug the supply gap, as sources have said. Trafigura has declined to comment.

US premiums are also at record highs, reflecting increased competition with Europe for available units and lower-than-expected production at the Valleyfield smelter in Quebec.

Noranda Income Fund, which owns the plant, has cut its 2022 production forecast by 15,000 tonnes to reflect operational problems in the first quarter of the year.

LME stocks in the United States have also been almost cleared out with just 550 tonnes available at New Orleans.

This is a perfect bull storm for the zinc market and analysts have lifted their price expectations accordingly.

Fitch, for example, has raised its 2022 average forecast from $2,900 to $3,500 per tonne, citing the prospect of a deeper supply deficit of 172,000 tonnes this year after an estimated 48,000-tonne shortfall in 2021.

TURBULENCE AHEAD? The depletion of freely available LME stocks has inevitably tightened time-spreads, the cash premium flexing out to $85 at the start of April and valued at a still wide $55.50 at Friday’s close.

The LME imposed backwardation limits on all its physically-deliverable contracts at the start of March, capping the potential cost of rolling a position overnight at 1% of the previous day’s closing price.

There is also a cross-contract 15% cap on daily price moves, which in the case of zinc translates into a swing potential of $638 per tonne.

That’s highly relevant given the potential for price volatility ahead.

LME traders have been eyeing nervously the build-up of open interest on May and June call options with strike prices stretching up to $5,000 per tonne.

Relative to Friday’s closing prices, the total upside volumes in place come to 88,000 tonnes and 93,000 tonnes in May and June respectively.

Those overhanging call options create a vacuum above the market. If the price accelerates into them, sellers will be forced to hedge their exposure by buying the underlying futures, creating a vicious upwards circle.

The risk of a melt-up similar to that which sent nickel briefly above $100,000-per tonne before the LME suspended the market is clearly there in zinc given the low available tonnage in the warehouse system.

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