“One man’s ceiling is another man’s floor.”

Hurricane turned super-storm Sandy ravaged the East Coast last week taking the lives of at least 110 people, destroying billions of dollars of property, leaving tens of thousands homeless and millions of others without power.  This tragic catastrophe has significant economic implications, which I will discuss at length, but only after prefacing it with a clear message of empathy for all of those affected by this natural disaster. 

In addition to this epic news event, this week marks the 57th Presidential election in the U.S. as well as the once in a decade change in leadership of the National Congress of the Communist Party of China.  The significance of these three events and the consequences of their outcome make this edition of “The Feldstein” an exercise in futility.

Last week showed a number of improving economic reports, many beating expectations.  The U.S. ISM and PMI both rose showing strength in new order growth. However, much of the growth came from only 8 of 18 sectors.   Those sectors were mostly tied to consumer goods.  Factories serving business customers, especially manufacturers of machinery, electrical equipment and transportation equipment reported declines.  The S&P/Case Schiller 20-city home-price index rose 2% in August from a year earlier and from 1.2% in July at the fastest pace in two years further bolstering the upward momentum in construction. Manufacturing climbed in China and India as well. Sentiment is improving as many believe the worst is over for most Asian economies.

Europe on the other hand is still trending lower.  Eurozone manufacturing dropped to 45.4 in October from 46.1 in September while UK manufacturing contracted more than expected to a 47.5 reading from 48.1 in the same period.  Unemployment in the 17 nation region rose to 11.6% with youth unemployment at 23.3% and Spanish youth unemployment at 54.2%!  Last week, the European Central Bank predicted a deeper slump this year than previously estimated and ECB President Mario Draghi, said the risks to the outlook are “on the downside.”  ArcelorMittal announced their “Flat Carbon Europe” division has lost $824 million through the first nine months of the year while Fiat forecasted a prolonged downturn in the European market.

Unless congress acts, the “fiscal cliff” will result in $600 billion worth of tax increases and cuts in federal spending.  JP Morgan said last month the combination will subtract a full percentage point from U.S. GDP in 2013.  The ongoing uncertainty surrounding the “fiscal cliff” has already weakened growth.  According to Tom Linebarger, CEO of engine manufacturer Cummins, “end users are reluctant to proceed with new purchases, apparently due to uncertainty about the U.S. economy and concerns about possible impacts from the fiscal cliff. There is also a high degree of uncertainty about the direction of the global economy, and at this point in time it is not clear when demand will improve.” Osh Kosh, Newell Rubbermaid and Rockwell Collins all announced planned job cuts in the future as a result of decreased demand and government spending. 

While the consequences of super-storm Sandy will still take a while to fully be known, there is plenty of speculation in the range of $30-$50 billion in economic losses. Regardless of the amount, fourth quarter production will decrease significantly, but that will essentially be transferred to the first quarter of 2013 as the Northeast rebuilds the damaged property and inventories.   Initial reports indicate the disruption to the steel and manufacturing industry has been relatively minimal.  An uptick in demand for construction related products, automobiles and white goods is expected. Reports indicate Sandy has taken a toll on some metallurgical coal production in West Virginia, Maryland and Virginia and on logistics in the North East.  Initially, we have seen prices on HRC and scrap futures move higher in anticipation. Compounding the matter, Severstal North America Inc’s Dearborn, Michigan facility suffered an explosion last Friday leading to a shut-down of the facility.  The company announced the shut-down will not “impact our customer deliveries.” Nevertheless, it is having an effect on supply as customers are shifting orders to other mills.  These events acted as a catalyst to the much anticipated additional $50/ton price increase out of AK Steel on Monday, November 5th and Nucor on Tuesday, November 6th.  Other mills are expected to follow with increases in the coming days. 

Prior to Sandy, the first round of U.S. and Chinese mill price increases were sticking.  Lead times were extending and mill sales representative were taking a much harder line to negotiations.  While the momentum in pricing power has clearly shifted into the hands of the mills, there are still plenty of headwinds that I believe will keep a ceiling on the price of rolled steel. 

U.S. Steel’s Gary Works in Indiana is back up and running after completing upgrades.  Higher relative production levels are expected.  Italy’s largest steelmaker, Ilva, was able to avoid a complete shutdown in response to environmental issues with the Italian government and expects to produce at a rate of 8 million tons per year.  China’s daily crude steel output during the last twenty days of October exceeded 2 million tons per day.  China’s September export volumes of hot rolled coil and sheet increased 46% from August to 581,548 tonnes, hitting the highest level so far this year.  Weakness in South Korean, Japanese and Taiwanese steel markets is no doubt a result of this excess supply of steel and this is spilling over globally.  Reliance Steel CEO Gregg Mollins said plate imports into the U.S. are “absolutely appalling” detailing the flood of Korean and Japanese imports into the U.S.  Prices of HRC in South Korea and Europe have stayed flat and prices in Brazil and Russia weakened as prices in China and the U.S. increased significantly. 

U.S. mill capacity utilization for the week ending October 27th plummeted to 67.9% reaching a new low for 2012.  Year-to-date, steel export handling fell 26.7% through September to 316,128 st from 431,257 st in the year-earlier period while the steel import volume handled rose 49.3% to 4.04 million st from 2.71 million st in the first nine months of 2011 for an increase of net imports of 1.45 million tons Y.O.Y. or 78%!  While the amount of imports is rather insignificant, the change is interesting as it indicates a growing acceptability of imports, which also keeps domestic producers honest.  The U.S. dollar hit a 3 week high vs. the Euro and 6 week high vs. the Yen further exacerbating the attraction to export steel to the U.S. Over the summer, I was on a BAML conference call concerning the global steel picture and I came away with the conclusion that every country is attempting to be a net exporter of steel.  The overproduction (relative to current economic demand) of steel and iron ore as well as the still unknown, but clearly substantial, supply shock of scrap metal from Sandy will keep prices within the 2012 price range. “However, some scrap sources noted that while the unpredictable weather could make collection difficult in the near term, hurricanes and other natural disasters typically bolster flows in the long term.  “The storm will increase the pricing in the area, but also will generate a good amount of scrap,” one east coast source said. “The amount of inflow that comes in after the cleanup is sometimes hard to keep up with,” (SBB Daily Briefing, 10/30/12). Until I see consistent and meaningful economic growth, the most logical conclusion is that there is a ceiling on HRC prices ($680) and we will continue to see the same cycles from last year play out in 2013.