Sharekhan Commodity Idea

Sharekhan Comtrade May 12, 2017

Buy Zinc; Buy Zinc over Gold amid a rebound in global growth, tightening of easy money policy

Sell 3 lots of Gold Mini May at Rs28,695 (COMEX spot gold at $1,254),
Buy MCX Zinc March at Rs168.40 (LME 3-month at $2,618)

Buy MCX Zinc April at Rs165.95 (LME 3-month at $2,585)

Key points
FOMC to go ahead with two more rate hikes in 2017
Zinc stockpiles at eight-year low
Eurozone manufacturing activities revive to six-years high
Chinas industrial production shows early sign of consolidation
Zinc deficit to continue in 2017
Gold overvalued as the global economy stabilises amid Fed rate hikes
Gold - safe haven bid could possibly be a wild card

Calls:

On April 10, 2017, we had released a fundamental report based spread call, where we advised selling three lots
of Gold Mini May at Rs28,695 ($1,254) and simultaneously buying MCX Zinc March at Rs168.40 ($2,616). The stop
loss for this call is Rs100,000, while we are looking for a target of Rs200,000 in a timeframe of six months to nine
months. So, rollover is required as we look for a significant target.

On April 11, 2017, we had advised buying MCX Zinc April at Rs165.95 (LME 3-month zinc at $2585) for a target of
$3000/$3200 in nine months to one year with a stop loss of $2,300. We also advised selling 12 lots of USD-INR at
the spot price of Rs64.45 so as to hedge the currency risk. Rollover is required as we are looking for a significant
target.

Call rationale:

Major global economies have started showing a recovery, and the zinc market continues to remain in deficit amid
shutdown of old mines and lack of major new discoveries.

The zinc smelters have been forced to reduce the Treatment & Refining charges on account of lower availability of
zinc concentrate. We remain bearish on gold, considering the fact that the global recovery has reduced the chances
of the central bankers easing their monetary policies further. This is negative for the yellow metal.

We believe that after raising interest rates in December 2015 and March 2017, the US Federal Reserve will go for two
more rate hikes this year. The outcome of the March FOMC meeting suggests that most of the FOMC members were
unanimous on the rate hike decision.

Major economies like the UK, Japan, Eurozone, China etc are showing improvements, which is a positive for zinc and
negative for gold.

The analysis of fundamental factors of the current scenario and the metals is given below:

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 Sharekhan Commodity Idea

A. Macro-economic rationale: High US consumer confidence is likely to boost growth.

1. The Fed is set to hike rates two more times this year. University Of Michigan Index

Most of the FOMC members have indicated that the

central bank will move sooner rather than later on its rate
hike agenda, as the US economy is showing encouraging
momentum. The US labour market is tightening, while
the PMI readings are also encouraging.

The markets are still underestimating the Feds

willingness to hike rates.

Also, the US consumer confidence is soaring and industrial

production is robust.

The ISM Services Index is near a 20-month high.

Strong Labor Market
US ISM Services PMI
US Non-Farm Employment Data

The ISM Manufacturing Index is also at a healthy level as

it has recorded eighth continuous expansion in activity. The US labor market remains strong. In march, the US
unemployment rate fell to its lowest level in almost
US ISM Manufacturing PMI
a decade. The unemployment rate fell from 4.7% in
February to just 4.2% - the lowest since May 2007.
US Unemployment Rate (%)

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As per the Fed, the slowdown in Q12017 GDP is temporary. Chinas industrial growth is likely to stabilise.

US GDP QoQ (%) China Industrial Production (%)

2. Global Growth Recovers Chinas manufacturing is in an expansion mode for the

last ten months.
We continue to get robust economic indicators out
of other major economies like Japan, the UK, the Caixin (China) Manufacturing PMI
Eurozone, and China the leading consumer of industrial
commodities.

The UKs manufacturing activity is also healthy despite

the Brexit shock.

UK Manufacturing PMI Index

Chinas services sector continues to expand too.

Caixin (China) Services Index

So is the UKs services sector.

UK Services PMI Index

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Caixin (China) Composit PMI 3. US treasury yields continue to rise

US two -year treasury yields have already surpassed

the level seen in December 2016. Although gold and
silver remain well above their respective lows seen in
December 2016, we think it is a matter of time only that
the bullion counters fall further.

US 2-Year Treasury Yield (%)

Eurozone manufacturing PMI is at a six-year high while

Chinas manufacturing activity remains above 50 for the
past nine months, mild deceleration has been seen in the
rate of expansion in the US and the UK.

Although Chinas GDP is languishing at a 25-year low, we

are likely to see some stabilisation.
4. The US inflation to approach target rate soon
Chinas QoQ GDP Data (%)
The US personal consumption expenditure index, the
Feds preferred measure for considering a rate decision,
slowed in April 2017, with the annual rate declining to
1.6% after hitting 1.8% during February (which was the
highest level since 2013). However, the Fed is confident
that the inflation rate would hit the target rate soon,
which means that the Fed will continue to move ahead
with its rate hike agenda.

US Core PCE Index (%)

Japanese manufacturing expanded for the eighth month

in a row.

Japans Manufacturing PMI

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B. Metal Specific factors this year with a tight outlook for both refined metal and
concentrates.
a) ZINC
Chinese industrial output declined during the first
LME Zinc Last Price quarter of 2017. Nine of the top 10 smelters in China, the
largest refined zinc producer, have suspended, or plan
to close production lines, as the treatment charges they
can collect from processing have failed to cover costs.

3. Zinc: spot TCs tightening in China as concentrate

supply dwindles

Zinc T&C charges continue to decline, as the smelters

vie for the shrinking pie of zinc concentrate supply.
Chinas largest zinc smelters jointly announced they will
curtail roughly 540,000mt of annualised capacity over
an unspecified period of time. Earlier in March, Chinas
largest zinc smelter, Zhuzhou, started an indefinite
1. Zinc deficit to continue maintenance period for 100,000mt of smelting capacity.

The global zinc market recorded a surplus during January In addition, Noranda, the second-largest zinc plant
to February this year. But, it must be noted that the zinc in North America has been running at 50% of normal
market had ended in deficit in the whole of 2016. The operating levels since a strike began on February 12.
galvanising metal rallied 65% in 2016. Typical annual zinc production at the plant is 270,000-
275,000mt per year.
As per the International Lead and Zinc Study Group, the
refined zinc market is expected to record a deficit of 4. Insatiable Chinese Demand
2.26 lakh tonne in 2017. Global demand of 14.3 million Construction and infrastructure account for more than
tonne will exceed supply of 14.1 million tonne; demand 60% of zinc demand. In China, investment in buildings,
will grow 2.6% YoY while supply will rise 6.7% YoY., factories and other fixed assets grew 9.2% in the first
2. Zinc: refined output remains flat quarter of 2017, while construction starts rose 11.6%
during the same period.
Chinas refined zinc production was 1.299 million tonne
during January-March 2017, down 0.15% YoY. Output in Chinas spending on infrastructure accounts for 25%
April is expected to be 421,000 tonne, with YTD output of total global zinc demand. As Chinas economy is
through January to April falling 1.7% YoY. doing well, the zinc prospects remain bright. Also, the
Automobile and Housing sectors are doing well in the
Glencores suspension of five lakh tonne capacity at major economies of the world. The tighter fundamentals
its Century mine and 1.50 lakh tonne production loss are set to persist, supporting zinc prices and reigniting
at the Lisheen mine have added to the supply woes. the bullish outlook for the market.
Consumption is expected to grow at a steady pace of 2%
5. Declining Stocks at Warehouses
Chinas Zinc Output 000 tonne
Stocks monitored by London Metal Exchange have reached
their lowest levels since June 2009. Zinc inventories stood
at 3.5 lakh tonne, of which 60% remains on warrants. LME
warehouse inventories registered significant outflows
during the first three months of 2017, declining 13% in
Q1, while inventory on SHFE declined 26% for the week
ending April 28 to 115,040 tonsne week, down for the
eight week to the lowest level since Feb. 2015.

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LME Zinc Inventories (in tonne) 2. Decline in US mint sale

In April, the US mint aggregated a total of 6,000 ounces

of gold, in various denomination of American Eagle gold
bullion coins, were down 71% from March sales, which
marked a 15-month low in demand. This is the worst April
performance in five years and the lowest sales pace in 16
months. For the year 2016, total gold bullion demand
was 172,000 ounces, down almost 51% compared 351,000
ounces sold during the first four months of 2016.

3. Long-term gold sentiment index turned toppish:

The index got close to intermediate top level in March as
it surged past 60. This indicator in the past has seen the
decline of the yellow metal.
b) GOLD
4. Junior mining stocks widely underperformed
Comex Spot Gold Prices ($/Oz) gold in March: Although the bullion complex has rallied
since December 2015, the performance of the miners,
especially the junior ones, remained a cause for concern.
It is to be noted that the sector often leads the metals.

C. Geopolitical concerns overblown

The bullion complex has rallied further lately on

geopolitical concerns. The risk assets declined briefly.

We took the position of buying an industrial metal over

a precious metal, when the wider markets were falling
and bullion counters were rallying on geopolitical
concerns. This rally in bullion in the last one month was
driven mainly by speculative interests using geopolitical
concerns on North Koreas possible tiff with Japan/ South
1. Lack of physical demand
Korea/the US. The speculative fervor rose further on a
Gold demand from the two Asian giants, India and China possible trade dispute between the US and China. The
(consume more than half of the worlds total annual rise of extreme right political party Front National (FN)
demand) remained muted in the first two months of in France boosted the demand for safe haven assets for
2017. However, March saw a sudden spike in buying gold further. However, with the defeat of Ms Le Pen, the
activities, where Chinas gold import from Hong Kong leader of the FN, the political stability seems to be back,
stood at 112 tonne. Chinas gold imports for 2016 totaled for now at least.
1,300 tonne, down 17% YoY. Chinese demand for gold fell
Overall, we think that the present geopolitical and
by 8% during January-February from the same period last
political concerns are overblown. Nonetheless, we would
year. Demand for gold in India, the worlds second largest
continue to monitor and analyse the geopolitical factors.
consumer, dropped by more than 40% and was just over
600 tonne in 2016, its lowest level since 2009, compared
to 800+ tonne in 2015. Although some of the Indian
demand can come back, as the impact of demonetisation
gradually diminishes, the overall demand is likely to be
muted amid continuing rally in the risk assets.

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Risk to our call: Conclusion:

The major risk to our call would be the Fed going We expect the precious metals complex to underperform
slower than anticipation in hiking rates. industrial metals for the next 6-9 months.

The worlds major zinc miners could be tempted to Zinc is likely to rally further on the deficit scenario and
bring some of this tonnage back online. growing global economy even amid tightening rates.

Trump trade fades: The market participants doubt the The global economy is looking healthier and the Fed is
possibility of US President Donald Trump succeeding expected to hike rates aggressively to avoid overheating.
in his plans to boost spending on infrastructure and Mr Trumps proposed plans on infrastructure spending
carry out the pledged tax reforms. would boost the US economy further. Major global
economies like China, Japan, the UK and the EU are also
A hard Brexit: In case of a hard Brexit scenario, recovering.
gold is likely to benefit due to higher demand for
safe haven assets. Such a scenario will hurt the UK Risks to our views come from a hard Brexit scenario,
economy and sour the relations with the European fading of the Trump reflation trade and the Fed going
Union. Industrial commodities are likely to fall in slower than expected on rate hikes. There is a certain
that case. element of uncertainty because of the protectionist
stance of Mr Trump as well. We will be monitoring our
The rise of the radical right parties in Europe. calls with respect to these risks.

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