This may be the big year for zinc, the laggard of the base metal rally, which barely budged for the past two years while most other metals reached multi-year highs.

Zinc began to move in late 2004 after China — the main factor driving base metal prices higher — switched from being a net exporter of the metal to a net importer for the first time in a decade. As 2005 began, the price had risen 25%, reaching a seven-year high of US57.6¢ a pound.

Based on encouraging supply/
demand fundamentals, analysts expect the price to rise even further and faster, making zinc this year’s darling of the base metals.

“Huge galvanized steel capacity in China will boost global zinc demand in 2005, even if North American motor vehicle production only edges up by 2% and U.S. housing starts eventually ease,” Patricia Mohr, Bank of Nova Scotia’s vice president of industry and commodity research, said in a speech at a recent mining industry event in Vancouver.

At the same time, supply is expected to grow only slightly because several smelters had to reduce output or shut down entirely as a result of environmental problems, power shortages and lack of feed from existing mines.

Short supply in the face of growing demand always spells higher metal prices, but what took zinc so long?

For a few years ending in 2001, Western
mine production of zinc increased by 720,000 tonnes and Chinese imports of zinc concentrates jumped by 350,000 tonnes. In the same period, zinc consumption increased by only 86,000 tonnes. The result was a buildup of inventories on the London Metal Exchange.

To make matters worse, about 347,000 tonnes of “hidden stocks” were dumped on the LME between November 2003 and September 2004, according to market research by Teck Cominco Ltd., one of the largest zinc producers in the world. The inventory was delivered to warehouses around the world in 2002 and 2003, but never reported. When the hidden inventory finally emerged, it put a lid on zinc prices even though demand for the metal was strong.

“We believe these deliveries have finished.
And in October, November and December 2004, LME [inventory] fell by a total of 107,000 tonnes with no significant deliveries in,” Teck Cominco’s research team wrote in a recent report.

Now that the dampening effect of stockpiles has eased, zinc is free to move in response to basic supply/
demand fundamentals.

Used primarily to rustproof steel, zinc has found a big consumer in China, which is using more of the metal to make galvanized steel for new buildings, power supplies and automobiles. The growth is unlikely to change in 2005.

“We expect no let-up in Chinese zinc demand, which will be underpinned in 2005 by double-digit growth in vehicle and appliance manufacturing output and the continuing priority to expand China’s power transmission infrastructure,” says the base metal research team at Standard Bank in London.

With strong demand and rising prices, it must be tempting for zinc producers to increase production. Tempting but not always possible.

“We have the largest zinc mine [Red Dog] in the world in Alaska,” says Michael Schwartz, a market research analyst at Teck Cominco. “What we can produce is restricted by environmental permits to ramp up production and by our port facility, which is open only four months of the year. We can’t do anything to push out more concentrates.”

Schwartz says most major mines in the world are in a similar predicament: they are either already running at full capacity or overcapacity. The zinc price has been in the doldrums for so long that many were forced, against their better judgment, to take the richest ore from their mines to stay afloat during the lean years. If anything, he says, production from the mines will decline as average grades move lower.

Compounding the supply problem is lack of investment in exploration in the past decade, meaning few new deposits are in the development pipeline, a common problem across the base metal board.

Schwartz says there are only three zinc deposits ready for development worldwide:
Apex Silver Mines Ltd.’s San Cristobal project in Bolivia, expected to come online in 2007; Aur Resources Inc.’s Duck Pond deposit in Newfoundland, expected to begin production in 2006; and Australia Stock Exchange-listed Lafayette Mining Ltd.’s Rapu Rapu deposit in the Philippines, expected to begin shipping concentrate by yearend.