By Chris Shaw

LME cancelled warrants for zinc more than trebled to more than 65,000 tonnes on August 5th, news that helped prices for the metal strengthen.

But according to Macquarie this rise in cancelled warrants shouldn't overshadow the fact zinc prices have overshot fundamentals, especially as the market remains well supplied and stock levels are high.

A potential loss of production from the Horsehead refinery in the US is a positive for the market's supply and demand balance, but even this is not enough to justify current prices of the metal in Macquarie's view.

As a result, the broker sees scope for some level of zinc price retreat in coming weeks to bring prices back to a range more justified by the market's fundamentals.

Turning to China, Barclays Capital notes the central bank last week outlined measures to support growth in the Chinese gold market, which include allowing more commercial banks to import and export gold and potentially allowing foreign suppliers to provide bullion for the Shanghai Gold Exchange.

The interest of Barclays is how these measures may impact on Chinese gold consumption given the country is now the world's second largest consumer of the metal. Supply and demand data show China consumes all of its production of more than 300 tonnes, predominately in jewellery form.

The other source of demand is as part of China's official reserves, Barclays estimating that if the Chinese were to move to holding 10% of the central bank's reserves in gold the country would need to purchase two to three years of global mine supply or around 20 years of domestic output.

For Barclays this suggests even though Chinese mine supply is growing, the strength of underlying demand suggests the country's increasing supply won't be enough to keep pace with potential demand over the longer-term.

The other major commodity news out of China is the Ministry of Industry and Information Technology has ordered more than 2,000 named companies to close obsolete production capacity by the end of September. The companies span the iron, steel, coke, aluminium, copper, lead and zinc sectors.

Goldman Sachs notes the Chinese government has a long history of making capacity curb announcements that in practice fall short of the original intention. The difference this time is specific companies have been named and specific closure targets given, something the broker suggests may mean the implementation of the order is more closely monitored.

Looking more closely at the proposed capacity closures, Goldman Sachs notes the amounts tend to be small from a national perspective and in sectors where capacity utilisation has been running at less than 90%.

This means the closures, even if fully implemented, are unlikely to have a major impact on Chinese production levels and therefore on global commodity markets. As Goldman Sachs points out, in some sectors such as aluminium and copper, new capacity expected to be commissioned this year will easily surpass the proposed capacity being closed via these new government orders.

Longer-term the moves make some sense with respect to achieving the Chinese government's objective of improving industry structure via consolidation and economies of scale, but in the view of Goldman Sachs these closures will achieve little in terms of addressing overcapacity issues.

On the Australian coal scene BA Merrill Lynch views the recent announcement of the Newcastle Coal Infrastructure Group (NCIG) of a stage 2 expansion as another positive for the sector. The expansion means capacity at the Newcastle terminal will increase from 23 million tonnes per year to 53 million tonnes per year by 2013.

On completion BA-ML estimates total Hunter alley port capacity will increase to 186 million tonnes per year, up from an expected 102 million tonnes per year this year.

The expansion is also positive for those companies supplying engineering design and procurement services, mining equipment and accommodation to the coal sector, which sees BA-ML retain its positive views on The Mac Services ((MSL)), Sedgeman ((SDM)) and Industrea ((IDL)). BA-ML rates all three stock as Buy.

Looking ahead, BA-ML expects Industrea and Emeco Holdings ((EHL)), which the broker rates as Neutral, to enjoy higher utilisation rates for existing assets as companies look to lift production from existing mines and develop new projects.

For Sedgeman, BA-ML expects increases in the order book as existing plants are upgraded and as new projects are sanctioned, while for The Mac Services the broker sees scope for further accommodation villages as work levels increase and more miners need housing.

The FNArena database shows others in the market are similarly positive on the prospects of the companies mentioned by BA-ML, as Sentiment Indicator readings stand at 0.6 for Emeco, 1.0 for Sedgeman and Industrea and 0.7 for The Mac Services Group.

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