Glencore's Zinc Rationale Defies History: Liam Denning

“You shut up!/No, YOU shut up!” is how schoolyard scuffles kick off. Miners tweak it slightly to: “You shut down!/No, YOU shut down!”

Ivan Glasenberg, the chief executive of Glencore, has long bemoaned miners’ tendency to literally dig themselves into a hole with too much supply. As concern about Glencore’s swollen debt has hit the stock price, Glasenberg has recently taken himself at his word, ordering a temporary shutdown of some of the company’s zinc output. That caused the price of the metal to jump 10 percent last Friday.

But history suggests Glencore’s fight to raise zinc prices sustainably could be a tough one.

Taking yourself out of the market in order to reduce excess supply can be a great strategy— but primarily for those rivals who keep producing and benefit from higher prices while your own reserves stay in the ground.

Sure enough, this week the marketing chief at one of said rivals, BHP Billiton, confessed himself “quite intrigued” about all the talk of cutting production, as he hadn’t seen any capacity being shut-in that was making cash. In other words, BHP is perfectly happy to let what it sees as higher-cost rivals -- whomever could he have meant? -- do the “rational” thing and withdraw.

The CEO of Vedanta Resources concurred, saying that while it was “rational” for Glencore to close capacity in the face of lower zinc prices, it was equally “rational” for Vedanta to keep churning the metal out at capacity. Clearly, “rational” is quickly establishing itself as the passive-aggressive term of choice in mining circles these days.

Cutting supply that isn’t earning a decent return is right to do, and zinc prices may rise further next year as a result. But a zinc floor can be shaky. That is largely because, for a metals market, the zinc market is pretty fragmented: Glencore is the world’s biggest producer, yet controls only around 10 percent of global supply.

Hence, the history of the zinc industry is littered with attempts by various cartels to coordinate on supply to juice prices, be it the failed European zinc cartel of the 1930s or the “Zinc Club” of the 1970s. 

Indeed, Glencore should know better than most how hard it is to tame zinc. In “The King of Oil", author Daniel Ammann describes a failed attempt to corner the zinc market in 1992 “the worst deal” of Marc Rich’s career, contributing to the trader’s decision to accede to the management buyout of his firm that formed Glencore.

In a paper from last December titled “150 Years of Boom and Bust”, Martin Stuermer, a research economist at the Federal Reserve Bank of Dallas, looked at the long-run pricing trends of zinc, lead, copper and tin. He concluded that, while supply cuts might have sustained copper prices for several years, their impact on zinc prices has tended to dissipate relatively quickly. (These reflect Stuermer’s own views rather than those of the Dallas Fed).

Instead, Stuermer wrote, sustained bull markets for zinc have been founded on demand shocks -- such as reconstruction after the Second World War, the introduction of the zinc penny by the U.S. Mint, and the China-fueled commodity supercycle of recent vintage.

This gets to the heart of the issue. In the supercycle, the high fixed costs of starting a zinc mine meant supply was slow to react. Existing producers, such as Glencore and the mining company Xstrata that it bought in 2013, could reap big profits as prices surged.

But now, China’s construction slowdown is hitting demand for steel, which ultimately drives much of the demand for zinc. The same high fixed costs for the capacity that was built to satisfy the supercycle will encourage producers to hold out as long as possible before throwing in the towel.

As you can see in the chart below, Glencore’s move has definitely helped raise zinc futures by between $100 and $150 a tonne compared to a week ago. But they remain well below where they were a year ago, or back in February 2012 when the Xstrata deal was announced. While Glencore is frustrated, buying Xstrata exposed the company much more to the mining sector’s sometimes ruinous exuberance.

Zinc futures are up (orange line vs. green line), but are still below a year ago (blue line) or in 2012 (red line).

(This column does not necessarily reflect the opinion of Bloomberg LP and its owners.)

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