Commodities Comment. Zinc market update: reflections on Palm Springs GLOBAL. Latest news. 28 February 2012

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1 GLOBAL LME cash price % change US /lb day on day Aluminium Copper Lead Nickel Tin Zinc Cobalt Molybdenum Other prices % change day on day Gold (US$/oz) Silver (US$/oz) Platinum (US$/oz) Palladium (US$/oz) Oil WTI USD:EUR exchange rate AUD:USD exchange rate LME/COMEX stocks Tonnes Change Aluminium 5,115, LME copper 300,475-3,025 Comex copper 82, Lead 368,175-2,325 Nickel 97, Tin 10,250 0 Zinc 867, Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research, February Analyst(s) 28 February Zinc market update: reflections on Palm Springs The International Zinc Association recently convened its annual conference in Palm Springs, California. This is a key event in the industry s calendar since this is where zinc miners and smelters typically settle annual treatment charges (TCs). These are the fees miners pay smelters to process raw materials to produce metal and determine how unit zinc revenue is shared between them. Terms are reported to have been settled between at least two major miners and smelters and, while it may be premature to refer to these as a benchmark since other substantial business has still to be settled, these initial agreements indicate that smelters will lose ~$33/t of zinc metal output compared with. This is a better than expected result for zinc miners but a tough financial outcome for smelters, especially high cost plants, with plain implications for related equities although these do not yet appear to be fully recognised in prices. The market for zinc metal is currently running a material surplus, the only debate in most of the two dozen meetings we held being about the size of the surplus. However, much of the high inventory that the industry is carrying is not readily accessible from a practical perspective and what we might call the addressable market is much better balanced, supporting physical premiums and ultimately exchange prices. Looking ahead, some business concluded in California suggests expectations of higher zinc prices over the next few years, which we discussed in our presentation to the Conference (request copy here). Latest news LME metals prices were mixed in trading on Monday. Sister metals lead and zinc rose by 1.8% and 0.8%, respectively, while copper at $8,555/t cash along with aluminium and nickel were broadly unchanged from Friday s close. Meanwhile, all precious metals prices fell with gold giving up 0.3% to settle at $1,772/t.oz in the PM fix. Positive economic data continues to flow from the USA. Pending new home sales increased by 2% MoM in January, according to preliminary data from the National Association of Realtors. Moreover, December sales data was also revised up. The Comex commitment of traders report published on Friday showed a drop in net non-commercial long copper positions as of 23rd February as sluggish price action saw a reduction in bullish bets. In contrast, the report showed an increase in the net long position across all precious metal markets, with gold net longs rising to 181,000 contracts, the highest level since September. Iron ore inventory held at 50 smaller Chinese steel mills has pulled back over the last two weeks to 31.7 days of cover, from 34.4 days previously. However, stock volumes have risen and it is instructive to note that iron ore prices have not risen at any time over the last year when mills have had more than ~30 days of inventory. This helps to explain why prices have remained stable through a period of apparent de-stocking and rising steel output. If end-user demand for steel takes more time to fully recover from its dip late last year, we can expect further near term softness in prices as the market sends a signal that the recent upturn in steel output has been unwarranted and raw material buying slows. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website

2 % of LME zinc price % of LME zinc price Macquarie Private Wealth Zinc market update: reflections on Palm Springs The International Zinc Association recently convened its annual conference in Palm Springs, California. This is a key event in the industry s calendar since this is where zinc miners and smelters typically settle annual treatment charges (TCs). These are the fees miners pay smelters to process raw materials to produce metal and determine how unit zinc revenue is shared between them. Terms are reported to have been settled between at least two major miners and smelters and, while it may be premature to refer to these as a benchmark since other substantial business has still to be settled, these initial agreements indicate that smelters will lose ~$33/t of zinc metal output compared with. This is a better than expected result for zinc miners but a tough financial outcome for smelters, especially high cost plants, with plain implications for related equities although these do not yet appear to be fully recognised in prices. The market for zinc metal is currently running a material surplus, the only debate in most of the two dozen meetings we held being about the size of the surplus. However, much of the high inventory that the industry is carrying is not readily accessible from a practical perspective and what we might call the addressable market is much better balanced, supporting physical premiums and ultimately exchange prices. Looking ahead, some business concluded in California suggests expectations of higher zinc prices over the next few years, which we discussed in our presentation to the Conference (request copy here). Miners win tug of war over treatment charges Regarding TCs, the terms reported are a base TC of $191/dmt at a basis zinc price of $2,000/t with escalators and de-escalators of +5 and -2, respectively, for the first $500/t either side of the basis price, which narrow further out from the basis price. It would probably be premature to refer to these as benchmark terms since other significant business has still to be settled but in our view it will be difficult for other smelters to secure any substantial departure from these terms. This result continues the long-term structural shift in unit revenue towards zinc miners and away from zinc smelters, whose revenue share is now close to all time record lows (Fig1 and Fig 2). Fig 1 Miners' revenue share from zinc price is rising Fig 2 and smelters' share of zinc price is falling Note: basis benchmark TCs at annual average LME cash prices. calculations use Macquarie s zinc price forecast of $2,100/t. Source: CRU, LME, Macquarie Research, February Note: basis benchmark TCs at annual average LME cash prices. calculations use Macquarie s zinc price forecast of $2,100/t. Source: CRU, LME, Macquarie Research, February Settlement of the basis zinc price at $2,000/t comes as no surprise since this is typically set within range of where the exchange price is trading at the time the agreements are reached (Fig 3 overleaf). The escalators and de-escalators reported represent a further reduction in price participation for zinc smelters that is, smelters share of changes in the zinc price relative to the basis price (Fig 4 overleaf) and reflect a continuing push on the part of zinc miners to move the pricing of zinc concentrates to fully flat terms without any price participation for smelters, as is already common in copper and, increasingly, in lead. Overall these terms will reduce the TCs realised by zinc smelters at all zinc prices between $1,000/t and $3,000/t (Fig 5 overleaf) compared with last year s levels. At the basis zinc price of $2,000/t the realised TC will be reduced by $18/dmt (9%), which works out to ~$33/t of metal output (assuming industry average concentrate grade of 53%-54%; Fig 6 overleaf). 28 February 2

3 1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000 2,100 2,200 2,300 2,400 2,500 2,600 2,700 2,800 2,900 3,000 1,000 1,100 1,200 1,300 1,400 1,500 1,600 1,700 1,800 1,900 2,000 2,100 2,200 2,300 2,400 2,500 2,600 2,700 2,800 2,900 3, US$/dmt of concentrate -37 US$/tonne zinc US$/tonne Share of change in zinc price Macquarie Private Wealth Fig 3 Basis zinc prices for benchmark TCs Fig 4 Smelters price sharing squeezed to new lows 4,000 3,500 3,000 Basis price Feb. average price in each year 2 15% 2,500 2,000 1,500 5% -5% Escalator De-escalator 1, % 0-2 Source: CRU, LME, Macquarie Research, February Source: CRU, Macquarie Research, February Fig 5 Realised TCs at benchmark terms Fig 6 Change in realised TCs at benchmark terms & terms compared Zinc price, US$/tonne Source: CRU, Macquarie Research, February Zinc price, US$/tonne Note: assuming industry average concentrate grade of 53%-54% zinc Source: CRU, Macquarie Research, February The TC outcome represents a better than expected result for zinc miners (Macquarie, 14th February ) who appear to have moved up by only ~$20/dmt from their opening positions whereas some smelters appear to have come down by ~$70/dmt from their original offers. It is also a challenging outcome for zinc smelters, especially high cost plants, which now face a more precarious future. Zinc metal surplus but addressable market balanced by storage deals While the consensus from most of the formal meetings and other conversations we had at the IZA Conference was that the market for zinc metal is currently running a significant surplus and that the industry has accumulated a high level of inventory from the surpluses of the last four years. However, the market has not been behaving as if in surplus because access to stocks is limited by carry trades (storage financed by price contango) and de facto bottlenecks on withdrawals from LME warehouses. Where surplus metal arises it appears to be absorbed in storage. As a result, a balance has been maintained in what we might call the addressable market between available zinc metal and end user demand, supporting firm physical premiums (Fig 7 and Fig 8 overleaf) and, ultimately, higher exchange prices than might otherwise have been the case. One leading metal supplier to a major regional market noted that negotiations for this year s annual contract premiums not only secured strong increases but were concluded more swiftly and easily than in any previous year. Meanwhile, past relationships between reported zinc stocks and prices appear to have broken down. 28 February 3

4 J A J O J A J O J J A J O J A J O J US$/tonne % LME price Macquarie Private Wealth Fig 7 Spot SHG zinc premiums Fig 8 Zinc premiums relative to exchange price USA del. Eur EXW F.East CIF 9% 8% 7% 6% 5% 4% USA del. Eur EXW F.East CIF 50 3% 25 2% 1% 0 Note: zinc ingots Source: CRU, Fastmarkets, Macquarie Research, February Note: zinc ingots Source: CRU, Fastmarkets, LME, Macquarie Research, February In China, some zinc metal stocks are reportedly being carried by smelters with indirect state support. Some of these stocks were accumulated in the falling price environment of 2H11 by smelters that often do not hedge operational price risk. Zinc demand related data readings have been weak but some signs of improvement With the zinc market in surplus it will probably come as no surprise that recent demand related data readings have been poor for zinc. For example, global output of galvanised sheet steel fell sequentially from 3Q to 4Q11. Typically, output rises over this time frame for seasonal reasons. Chinese zinc demand remains quite soft currently. European demand splits between the north of the region, where demand is described as quite good, and the south where it is still weak. Meanwhile, US demand is reported to be picking up quite briskly although it is still said by some to be below year earlier levels. Positive signals on the longer term zinc price outlook While there is little reason for fundamental excitement in the short term zinc price outlook, there are reasons to be more optimistic about the medium- to long-term price outlook. Ultimately, these relate to the forthcoming closure of four key zinc mines over the next three-to-four years, as well as declining output at a number of other significant operations. On paper, there appears to be sufficient supply in the pipeline to offset these losses but doubts remain about whether these will be brought on line in time (Fig 9 overleaf). Based on some of the business that was talked about during the conference, it would appear that some well established zinc miners and traders, at least, are optimistic about the longer term price outlook. For example, it is in part anticipation of higher zinc prices that appears to be driving miners determination to drive down price participation escalators on benchmark TCs. We also note reports of one miner selling zinc concentrates to a leading trader with a zero TC at a basis price of $2,000/t. This is obviously "out of the money" at the headline level (surely no smelter would agree to process material for free!). However, it is important to note a substantial escalator, reported to be ~25, is said to be attached. The tonnage committed for this year is very small, rising to a more material volume in However, the miner is reported already to be running behind schedule with the result deliveries may be pushed out. The significance of all this is that it appears to suggest a bullish outlook on the zinc price in the medium term on the part of the buyer. We certainly share the view that there is a possibility of a zinc price spike emerging over the next three years. It is perhaps premature to call it a probability at this stage but the possibility is rising. Perhaps the catalyst will come when the first of the major zinc mine closures that are pending is finally announced, focusing investors attention on the supply side challenges ahead. 28 February 4

5 Macquarie Private Wealth Fig 9 Key zinc mine closures, declines, expansions and new projects, ('000t zinc contained) Mine Location Operator Output in Output in 2015 Change -15 Comments Closures Century (3) Australia MMG Closure expected 2H 2015 Brunswick (7) Canada Xstrata Closure expected 1H 2013 Lisheen (12) Ireland Vedanta Closure expected end 2013 Perseverance(15) Canada Xstrata Closure expected 1H 2013 Depletions Anatmina (5) Peru BHPB Copper-zinc mine; prioritising copper recovery Zyranovsk (21) Kazakhstan Kazzinc (Glencore) Golden Grove (29) Australia MMG Copper-zinc mine Red Dog (2) USA Teck US EPA restrictions Key closures / depletions 1,990 1, Expansions McArthur River (9) Australia Xstrata Feasibility study. Final decision to be taken Mount Isa (4) Australia Xstrata Xstrata making parallel investments in smelters Rampura-Agucha (1) India Vedanta Cerro Lindo (25) Peru Volcan Penasquito (14) Mexico Gold Corp Precious metals mine; zinc is a by-product Garpenburg (26) Sweden Boliden New mines Dugald River Australia MMG Environmental permits pending. Start up 2H 2014 Bracemac Canada Xstrata Copper-zinc mine. Start up 2013 Kyzyl Tashtygskoe Russia Zijin Mining Start up Perkoa Burkina Faso Glencore Start up Lalor Lake Canada HudBay Start up end Velardena Mexico Penoles Start up 2013 Neves Corvo Portugal Lundin Restarting zinc circuit Lombador Portugal Lundin Final devt decision pending. Start up 2014/15 Key expansions / new mines 1,560 2,830 1,270 Note: numbers in brackets denote ranking of existing mines in global output league in. All data rounded to 5,000t data are forecasts Source: Company Reports, CRU, Wood Mackenzie, Macquarie Research, February 28 February 5

6 Macquarie Private Wealth Monday 27 February Closing price * Closing price * 27-Feb Feb Feb Feb-12 % ch. day YTD Ave US$/tonne US /lb US$/tonne US /lb on day US$/tonne US$/tonne LME Cash Aluminium 2, , ,148 2,395 Aluminium Alloy 2, , ,053 2,262 NAASAC 2, , ,183 2,379 Copper 8, , ,058 8,811 Lead 2, , ,099 2,398 Nickel 20, , ,870 22,831 Tin 23,670 1,074 23,815 1, ,579 26,021 Zinc 2, , ,986 2,191 Cobalt 31,250 1,417 31,250 1, ,220 35,702 Molybdenum 31,750 1,440 32,250 1, ,059 34,381 LME 3 Month Aluminium 2, , ,179 2,420 Aluminium Alloy 2, , ,078 2,259 NAASAC 2, , ,129 2,261 Copper 8, , ,074 8,825 Lead 2, , ,126 2,390 Nickel 20, , ,908 22,857 Tin 23,705 1,075 23,850 1, ,627 26,036 Zinc 2, , ,000 2,210 Cobalt 31,250 1,417 31,250 1, ,627 35,507 Molybdenum 31,750 1,440 32,250 1, ,059 34,554 * LME closing price hrs London time. Year-to-date averages calculated from official fixes. Gold - London PM Fix (US$/oz) Silver - London AM Fix (US$/oz) Platinum - London PM Fix (US$/oz) Palladium - London PM Fix (US$/oz) Oil WTI - NYMEX latest (US$/bbl) EUR : USD exchange rate - latest AUD : USD exchange rate - latest Commodities Prices 1,772 1, ,660 1, ,706 1, ,512 1, Exchange Stocks Change since last report Cancelled End-11 Ch. since (tonnes) 27-Feb Feb-12 Volume Percent warrants stocks end-11 LME Aluminium 5,115,775 5,115, ,620,175 4,970, ,375 Shanghai Aluminium 327, , , ,803 Total Aluminium 5,443,544 5,443, ,178, ,178 LME Copper 300, ,500-3, , ,900-70,425 Comex Copper 82,279 82, ,817 2,462 Shanghai Copper 216, , , ,867 Total Copper 598, ,885-3, % - 543,936 54,904 LME Zinc 867, , , ,700 46,025 Shanghai Zinc 380, , ,186 16,602 Total Zinc 1,248,513 1,248, ,185,886 62,627 LME Lead 368, ,500-2, % 35, ,075 15,100 Shanghai Lead 37,709 37, ,586 7,123 Total Lead 405, ,209-2, % - 383,661 22,223 Aluminium Alloy 137, , % ,880-5,160 NASAAC 156, , , , Nickel 97,398 97, % 4,476 90,048 7,350 Tin 10,250 10, ,515 12,190-1,940 Source: Comex, LBMA, LME, Nymex, Reuters, SHFE, Macquarie Research 28 February 6

7 Macquarie Private Wealth Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+ Neutral expected return from - to + Underperform expected return <- Macquarie First South - South Africa Outperform expected return >+ Neutral expected return from - to + Underperform expected return <- Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 6 in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 4 in a year. Low medium stock should be expected to move up or down at least 25 3 in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 31 December AU/NZ Asia RSA USA CA EUR Outperform 56.59% % 44.53% 75.28% 49.46% (for US coverage by MCUSA, 10.53% of stocks covered are investment banking clients) Neutral 33.45% 20.55% 38.96% % 32.36% (for US coverage by MCUSA, 10.96% of stocks covered are investment banking clients) Underperform 9.96% 13.85% 6.49% 5.27% 2.25% 18.18% (for US coverage by MCUSA, 0.44% of stocks covered are investment banking clients) Company Specific Disclosures: Important disclosure information regarding the subject companies covered in this report is available at General Disclaimers: This research has been issued and distributed in Australia by Macquarie Equities Limited ABN ("MEL"). MEL holds Australian Financial Services Licence No and is a Participant of the Australian Securities Exchange Group. 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