“If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.”

Most of the time, Q1 is a strong season for the steel industry.  Yet, 2013 thus far has been anything but strong.  Nevertheless, there seems to be a loud drumbeat that strength is just around the corner. 

I’ve seen this first hand in the futures markets over the past six weeks.  During December, January futures were trading strongly around $650.   Toward the end of the year, lead times at the mills were shortening and physical prices were transacted at $620/st.   This was quickly disregarded as a holiday funk, sure to be reversed in the New Year.  However, in the first week of 2013, the phones were quiet and the wave of strong orders that was expected failed to materialize.  The strength in HRC futures moved to February and March, where you could find buyers willing to pay $655.  That first week had New Year’s Eve and Day in it; half of the industry was still on vacation.  It wouldn’t be till the next week when the flood of orders would come in, fill the mill’s order books, push lead times out and prices up.  And iron ore, whoa, iron ore was screaming higher, north of $160/mt in the spot market!  But the flood of orders didn’t materialize in that second week and prices in the spot market continued to decline.  Now, we’re in the third week of 2013 and still no flood of orders.  Lead times remain anemic and spot prices are steadily drifting lower.  Those strong bids for February and March futures have moved out to March and April now bid $650.  Which is logical considering the flood of orders is just around the corner.

And the CRU comes out each week showing that there is underlying strength, right? January’s first print was $639, last week at $635 and today’s print of $624.  How can the CRU print an average of $633 for the first three weeks if spot deals are occurring at $600?  What gives there?  I’d love to hear your opinion (please comment below).

Yesterday, I read a report in the SBB daily that deals for 10,000-15,000 tons are being executed at $600/st.  Sources told me, you can get deals done all day, every day at $600 regardless of tonnage.  Today, I have heard spot steel being available sub $600 at the same time rumors that a steel mill price hike is coming (and it’s going to be cloudy in Cleveland soon).  Would the steel mills risk killing the little demand there is to boost prices?  What to believe? 

In markets, whether physical or financial, there are signals and there is noise.  All of the anecdotal reports, one-off quotes of an anonymous industry source in the rags, self-serving industry newsletter writers fabricating vague rumors without regard for the consequences (or accuracy) of their comments, short-term price variations and biased dribble spewing from the mouths of the guests on CNBC are examples of noise.   Don’t listen to the noise. 

Finding signals isn’t easy either.  One would have expected the significant run up in iron ore and global steel prices would inflate domestic prices, but they haven’t, at least not yet; curious.  As one of our OEM customers put it, “I could not care less about what iron ore is doing in China.”  Pricing of iron ore for many mills is based on some form of the previous quarter’s IODEX index, so higher input prices won’t affect input costs till next quarter, (mills are currently living off the $100-$120/mt prices from Q4), assuming they stay up long enough (3 month ore swaps are 9% off recent highs).  Also, many U.S. mills employ electric arc furnaces, which use scrap, coking coal, pig iron and natural gas rather than iron ore.  Scrap was flat in January and early forecasts are for February scrap prices to be down, (but again this is just noise).  And has anyone noticed the balmy (relatively speaking) weather in the Midwest?  Natural gas prices are down 3% since early December, but have been as low as down 12% as of last Thursday (Jan. 10th).  Coking Coal FOB Australia and Brazilian Pig Iron are up 0.67% and 1.55%, respectively, since Dec 7th while Ore is up 27%.  I find this to be puzzling.  First, considering the “oversupply” in ore that rattled the market late last summer.  Second, why didn’t the other raw materials and inputs follow iron ores magnificent rally?  Last, what is going to happen with all that ore?  I see two scenarios: 1) turn it into steel and 2) Leave it on the ground.  If scenario 1 plays out without a pick-up in demand, were looking at “global steel export fest II” this summer.  If scenario 2 plays out, a lot less ore will need to be procured in the coming months so it’s reasonable to expect that the price of ore would decline, maybe plummet, if there is a repeat of last summer’s (deflationary) purchasing behavior.  Again, we will see how this plays out over the coming weeks and months.    

Steel prices are primarily driven by the mill’s need to fill their order books as they have to keep making steel or otherwise incur heavy costs to shut down their furnaces.  If a mill’s lead time is dwindling, that most likely means the mill is having a hard time getting orders at current asking prices.  The mill can wait it out for a certain amount of time, but eventually the forces we all learned in economics 101 take over and the suppliers have to induce buyers with lower prices.  Other supply side issues are mixed.  On one hand, prices for raw materials have remained reasonably stable as mentioned above and are not currently pressuring producer’s margins.  On the other hand, the attraction of global steel imports has diminished as steel prices abroad have rallied, due to currency advantages from the relative strength of the Euro and RMB versus the U.S. Dollar as well as much improved sentiment in China, while prices in the U.S. have been decreasing.

So what about the demand side?  We solved the fiscal cliff right? Everybody back in the pool! Actually, the solution to the fiscal cliff not only reinforced the fact that our current batch of politicians are more dysfunctional than the Kardashian family (first ever Kardashian reference btw), but also raised taxes on everyone, even more so for those earning above $400,000/year (many of whom are small business owners who are going to hire less, spend less and take less risks, oy vey).  These austerity measures are going to negatively affect GDP, which was estimated at 1.7% by the CBO if the fiscal cliff was extended a year (analyst forecasts are reliably overly optimistic (and usually incorrect), but for the sake of the next point, we need to start somewhere).  According to a regression model developed by former USS market research director, Glenn Kidd, steel consumption is related to economic growth; sounds reasonable. According to his model, GDP growth between 0 and 1.7% translates to a contraction of steel consumption between – 7 and 0% (that’s a negative seven to be clear). 

Oh yeah, I forgot to mention the impending budget negotiations to either raise the debt ceiling or cut government spending, which lead to some amount of decrease in GDP.    Do you remember how friendly our Politicians were to one another in public following the election with respect to the fiscal cliff?  Remember how that turned out?   Did you hear what House Speaker John Boehner said to Senate Majority Leader Harry Reid? Hmmm, I wonder how this budget negotiation will wind up.  What happened at the last budget negotiation in 2011?  Oh yeah, they waited till the last minute, negotiated an awful deal that led to the U.S. credit rating being downgraded by S&P and, arguably, caused the S&P 500 to drop by 10% in three weeks.  This time it’s different though, right?

But demand is coming back; the ISM printed 50.7 for December which signals EXPANSION!  This is true, however, if you download the latest report (see link below), you will find the following under “Performance by Industry” (fyi, industries not reported are flat month over month):

“Of the 18 manufacturing industries, seven are reporting growth in December in the following order: Furniture & Related Products; Paper Products: Petroleum & Coal Products; Wood Products; Primary Metals (Mills); Computer & Electronic Products; and Food, Beverage & Tobacco Products.  The nine industries reporting contraction in December – listed in order – are: Nonmetallic Mineral Products; Chemical Products; Miscellaneous Manufacturing; Plastics & Rubber Products; Fabricated Metal Products; Transportation Equipment; Machinery; Electrical Equipment, Appliances & Components; and Apparel, Leather & Allied Products.”

More…

“The five industries reporting growth in production during the month of December are: Furniture & Related Products; Petroleum & Coal Products; Paper Products; Primary Metals; and Computer & Electronic Products.  The seven industries reporting a decrease in production – listed in order – are: Nonmetallic Mineral Products; Chemical Products; Machinery; Miscellaneous Manufacturing; Food, Beverage & Tobacco Products; Fabricated Metal Products; and Apparel, Leather & Allied Products.”

My interpretation of this report is that steel producers were producing relatively more steel in December than November for customers that were demanding relatively less steel in December.  Don’t let the aggregate ISM number fool you.  Manufacturing does not look to be expanding based on this report.  When there is an increase in supply and a decrease in demand, draw your supply & demand lines and follow the price of HRC down.  Actually, that is what is happening, but not being reported and recognized quickly enough by indexes and futures markets. 

But Feldstein, what about the duck?

First, Lola’s Duck entrée is delicious.  Next time you are in Cleveland, I highly recommend it. 

More importantly, the steel industry should be seasonally strong in January and it is in fact weak. If Black Friday (shopping) or back-to-school season is weaker than expected for retail, it is more than reasonable to expect that foreshadows weakness in the industry for the near future.  Perhaps steel demand changes drastically in the coming months (and I really hope they do!), but if things are weak when they should be strong (i.e. now), recognize the duck.  This could be another tough quarter for the steel industry. 

Thanks for reading and HAPPY NEW YEAR! (I know that’s kind of ironic)

 

http://www.ism.ws/ISMReport/MfgROB.cfm?navItemNumber=12942