What Fuels the Short Squeeze of SHFE Zinc with Historical High SHFE 2210 and 2211 Contract Spread?

SHANGHAI, Oct 12 (SMM) - The market has been quite sensitive to the squeeze scenario after experiencing a historical short squeeze in LME nickel this March. As a metal variety with low inventory levels, zinc has attracted a lot of attention from the market. After the National Day holiday, SHFE zinc continued to see the inflow of capitals. Therefore, under the background of a wide spread between SHFE 2210 and 2211 contract at 1,360 yuan/mt, a potential short squeeze re-emerged. Below is SMM analysis on the evolution that leads to this round of short squeeze.

Looking back at this year so far, the soft squeeze of SHFE zinc is not achieved overnight. From the perspective of social inventory and open interest of SHFE front-month contract, there has always been the possibility of soft squeeze since the third quarter.

First of all, zinc ingot social inventory has been falling rapidly since this July. And from the perspective of the delivery of SFHE 2207 on July 15, the long positions were above 8,700 lots, equalling to over 40,000 mt of spot zinc ingot. The social inventory in Shanghai, Guangdong and Tianjin on the same day stood at 35,100 mt, 46,900 mt and 58,700 mt respectively. According to SMM understanding, some of these social stocks were owned by the longs. In this case, the SHFE front-month and next-month contract spread once expanded to 710 yuan/mt, showing initial signs of short squeeze. 

After the national Day holiday, the open interest of SHFE 2210 recorded a new high at around 15,500 lots, meaning that the shorts shall prepare at least 75,000 yuan/mt of zinc ingot before October 15 to delivery the front-month contract. According to SMM zinc ingot social inventory across seven major markets, the social inventory added 13,600 mt to 84,700 mt during the week-long holiday, which is still low. With the centralised holding of long positions, the current spot inventory is insufficient for the shorts to prepare for the upcoming delivery. Meanwhile, galvanising plants have high restocking demand post the holiday amid busy production, solidifying the ground for a short squeeze. Nonetheless, as the open interest fell 5,000 lots yesterday October 11, the shorts may have left the futures market and chosen to deliver with the smelters.

On the fundamentals, low inventory and wide SHFE front-month and next-month contract spread has enabled a short squeeze. What about the future?

On the supply side, imported zinc concentrate prices are much lower than that of domestic concentrate with rising SHFE/LME price ratio. At the same time, with sufficient raw materials stocks built by the smelters, the mines and traders have to significantly increase the TCs, allowing higher profits of smelters. Rising TCs may encourage some smelters to greatly raise their production. Hence the monthly refined zinc output is likely to rise to 540,000-550,000 mt in October-December. However, resurging pandemic may restrict the transportation of refined zinc though the production will remain unaffected, that is, the increase in social inventory may come later than expected.

On the consumption side, the orders for galvanised products increase under the policy of “guaranteeing housing delivery”, but the sustainability remains to be seen. The die-casing and zinc oxide sectors are still weak without obvious signs of recovery. Taking into account the pandemic situation, cooling weather as well as environment protection requirements, the improvement in consumption will be unable to offset the growth on the supply side, resulting in oversupply.

Meanwhile, after SHFE/LME price ratio rose to 8.28, some traders have started the import businesses. But as a number of leading brands like KZ and SMC will be re-exported afterwards, the actual import volume of refined zinc will be limited. Therefore, though the social inventory is expected to usher in increases, the scale may fall short amid restricted transportation on spreading pandemic.

On the whole, October is the best time for a soft squeeze. If the inventory accumulation in November is limited, it may continue to provide opportunities for short squeeze, but the weakening consumption may reduce the possibilities.