LONDON, Mar. 1 -- Improving steel consumption will buoy zinc over coming months, but the chances are high for a dip later in 2010 as producers prematurely restart idled capacity.
Investors are starting to see the first signs of life in a steel industry that has languished since 2008 because the world economic downturn devastated the auto and construction sectors.
But a global rise in auto sales is supporting the demand outlook for steel and its galvanizer, zinc.
"We're seeing a big pick up in steel production globally which has got to be very positive for zinc consumption," said David Wilson, an analyst at Societe Generale.
"The auto sector globally is picking up strongly."
Autos data in January was impressive, with China's passenger car sales jumping 115.5 percent on the year and Indian monthly car sales hitting a record high. U.S. car sales are also improving.
Short-term government-backed car scrappage schemes worldwide aimed at boosting flagging economies have helped auto sales to swell, but analysts see real demand improving as well as world economies emerge further from recession.
Zinc prices neared $2,200 a tonne on Feb. 26. Prices have shed some 15 percent so far in 2010 on concerns about Chinese monetary tightening, while worries about debt-laden Greece have spurred the dollar and made metals costlier for non-U.S. buyers.
But China's demand remains strong, as hefty infrastructure spending forges on in the world's top base metals consumer.
Analysts recently polled by Reuters see 2010 prices averaging a bit higher, around $2,300.
Zinc hit $2,736 in early January, its peak so far this year and its highest since March 2008, while its low so far in 2010 was $1,935 on Feb 5. In November 2006, prices hit a record high of $4,580 tonne.
In response to a better demand outlook, premiums in Europe -- the amount paid by consumers over and above the LME cash price to cover the costs of shipping and delivering metal -- have risen to about $110 from $60 a year ago.
On the downside, though, the OECD construction sector is still struggling, with commercial construction likely to remain a weak spot in the U.S. economy in 2010.
But positivity about improving demand prospects looks set to give way to concerns about over-supply later this year, as signs of economic improvement are spurring producers to ramp up production in an already flooded market.
The global zinc market looks poised to register a surplus of about 200,000 tonnes this year, a recent Reuters poll showed, after a wave of production restarts in the second half of 2009 coincided with weaker-than-expected demand.
"Production is going to be stronger than the recovery we've seen in demand," said Gayle Berry, an analyst at Barclays Capital.
"About 550,000 tonnes of smelting capacity outside of China has been restarted over the past 6 months or so because of the improvement in prices, so we are seeing global zinc production recover and that recovery is going to gain momentum."
Highlighting over-supply, zinc stocks at LME warehouses have jumped 50 percent in the past 12 months, to about 542,000 tonnes versus some 352,000 tonnes last February. And stocks rose 90 percent in 2009.
And this follows a steep surplus in the world zinc market last year -- 445,000 tonnes according to the International Lead and Zinc Study Group (ILZSG) and 207,000 tonnes according to the World Bureau of Metals Statistics. The ILZSG cited 445,000 as the largest surplus since 1993.
Top zinc producer China -- whose year-on-year output of refined zinc jumped 11.6 percent to 4,416,100 tonnes in 2009 -- has already restarted a substantial amount of idled capacity.
With many Chinese restarts out of the way, the next big threat to zinc prices is the great potential for reactivations in Europe and North America.
Big European producers such as Sweden's Boliden and Belgium's Nyrstar have been working on raising output. And with zinc prices looking set to firm, other Western producers are poised to follow suit.
"There's a fair amount of idled capacity still out there -- maybe 500,000 tonnes," said Robin Bhar, an analyst at Credit Agricole, who sees zinc hitting a 2010 high around $2,800 in the second quarter, and a low of around $1,800 later in the year.
"That's the big risk. If producers prematurely restart and flood the market you potentially will see the market surplus building, and that will put pressure on prices," Bhar said.
Over coming months investors will keep a keen eye on the activities of producers across the West.
But even if producers do not restart output before the market is ready, the fear that they could do is enough to cap prices this year.