12 November 2009

LEAD & ZINC SPREAD

-Ample of opportunity

Lead and zinc have always been talked together owing to their very nature of being extracted
together as lead being found in ore with Zinc, silver and copper and is extracted together with these
metals. Thus they have been moving in tandem since long with correlation of 98% and above.

Although the recent surge in prices have belied the basic fundamentals of supply and demand
in market, prices have moved substantially up, guided by global factors like fall in dollar index by
close to 8% in current year and recoup of equity markets. Fall in dollar index leads to increased
appeal of base metals as a safe inflationary hedge. Moreover Chinese imports, be it for usage or
stockpiling has been a constant factor adding on to price gains.

The battery metal, LEAD turned out to be the best player among group in the 3rd quarter, prices
rallied on account of continuous supply disruptions caused due to poisoning issues and mine
disruptions. Batteries, both vehicular and industrial, account for almost 80 percent of the heavy
metal's consumption. Global lead prices have made strong gains this year, helped by low stocks,
concerns about supplies from top producer China and not so significant market imbalance.

On the other hand, the galvanizing metal, ZINC is frequently a by-product of lead smelting (and
vice versa), so there exist a perceived thought process that the prices have followed lead higher in
early September, driven by short covering and fresh speculative buying on the back of the Chinese
government’s sudden come down hard on smelters responsible for lead pollution and poisoning.
There laid an inherent risk that zinc’s production could also be affected if lead outperforms.
Moreover in the recent times, the spill over of pipeline in mines of Australia added on to gains in
Zinc prices taking it to multi months high.

Now coming on to the opportunity part of our analysis, we find that lead and zinc have provided
numerous prospects to make money with spread widening and contracting very frequently.
Looking at the count matrix for Jan 2008 to Nov 2009 (till date), we see that the mean difference of
spread is INR 5.54/kg; however a very high standard deviation of 8.75% suggests high volatility.
The prices mainly hovered in the range of 5 to -5 difference, totaling to 48.38% or 270 out the total
data points of 558. However opportunities lie on the extreme points between 10 to 25 on higher
sides or between -5 to -15 on the lower side. We find that there were 138 occurrences between 10
to 25, making 24.73% of total data points while 44 occurrences between -5 to -15 making 7.88%
opportunities. These short term sustainable differences in prices of lead and zinc render huge
opportunity .making

Lead & Zinc Spread - Continuous chart

Range Counts
Between 30 to 35 5
Between 25 to 30 8
Between 20 to 25 33
Between 15 to 20 42
Between 10 to15 63
Between 5 to 10 93
Between 0 to 5 160
Between -5 to 0 110
Between -10 to -5 37
Between -15 to -10 7
The current market scenario is as under:

Prices as on 11th Nov 09

LME
LEAD 3-month forward $2304.50/tonnes
ZINC 3-month forward $2184/tonnes
Current Difference is 120.5
Mean difference is 132.31
MCX
LEAD Oct futures Rs. 106.75/kg
ZINC Oct futures RS. 101.25/kg
Current Difference is 5.5
Mean difference is 5.54

Market is expecting stable upside for both commodities owing to not so significant market
surplus with stable signs of marked improvement and demand from the automobiles sector for
lead-acid battery to come up in winter season. Thus conclusively we expect lead prices to take
initial correction and then show a bullish trend with demand building from U.S. battery season.
Moreover recovery in the construction sectors in Europe and the U.S. and the auto sector
rebounding, both account for around 70 percent of demand, may propel zinc prices higher in
coming months.

The above factors suggest that the spread could be taken up as an opportunity to earn quick
bucks. The average difference maintained by the two metals in 20 months is close to Rs. 5.54/kg,
although the momentum highs and lows of Rs. 34.50/kg on 19th Feb. 2008 and RS. -12.55/kg on
26th Dec. 2008 respectivly cannot be ruled out. It is this difference, even if shortlived, that instills
opportunities in the market to earn risk free money for investors.

We see that the current difference is 5.3, and in the last few days it is moving up/down in range
of +2/-2. The upside widening could be around 9-12 levels, while contraction can be close to -2
levels. Conclusively in times to come, we expect the difference to widen from the current levels
of 5 after making a short correction on downside to 2-3. This downside correction instills an
occasion to grab gains.
 There exist 5 possibilities for spread to rise from the current levels:
1. Lead and zinc rise, but lead outperform
2. Lead and zinc fall, but zinc to fall more
3. Lead rise, zinc fell
4. Lead maintain the level, while zinc fell
5. Lead rise, while zinc maintain same level

Looking at the existing market fundamentals, out of the above 5 possibilities we expect first
one to turn out well i.e. lead and zinc both to rise but the pace of lead would outperform that of
zinc. Thus we suggest entering the market when spread difference stand near 2-3 and widen
up to 9-12 levels.

For this view to hold good, we recommend buy lead and sell zinc.

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