“It’s Déjà vu all over again” – Yogi Berra
Chinese production is up of late with production of rebar hitting a record high in October. This occurred while four major Chinese steel mills conducted maintenance on blast furnaces in October and November. China’s tendency to over produce steel is well known, but this latest round was perhaps boosted by anticipated stimulus measures and infrastructure projects to be announced when the new Chinese government took over in early November. To the contrary, the new government not only made no such announcements, but also took a very conservative approach toward their political and economic ambitions. Further exacerbating the issue, property prices in China continued to increase leading to expectations of further government restraint of construction projects (to slow inflation) as well as winter weather hitting Northern China leading to a normal seasonal slowdown in construction activity. Bullish sentiment quickly eroded and prices of iron ore, billet and rebar have sunk by about 6%, 5% and 7.5%, respectively, from early November highs. Chinese scrap interest has also sunk to its lowest level in ten years.
While all of this was going on, demand from Turkish scrap buyers was helping to push up scrap prices. One of the initial effects of Superstorm Sandy was that it shut down U.S. east coast scrapyards, slowing the flow of U.S. scrap exports to Turkey. As a result, there was an uptick in scrap prices in a number of European countries that filled the void. However, after the U.S.E.C. recovered from the storm, east coast scrap yards became overwhelmed with scrap. Some estimates are calling for the huge onslaught of scrap to continue for months.
Despite weak global demand, especially from austerity stricken Europe, steel mills all over the globe began a campaign of price hikes starting in the U.S. with AK Steel’s $40 price increase on October, 17th. While the hikes have yet to meaningfully take hold in Europe, Russia and East Asian steel markets, buyers accepted them in the U.S. and China. Those mills were able to fill their order books and bullish sentiment was strong. The HRC futures markets quickly priced in the full $90 increase and a number of trades for first quarter futures occurred at $655-$660/ton. Then demand started to slow down the week of Thanksgiving and there has not been much of a pick-up in steel demand following the holiday this week. Perhaps this was a result of the price hikes pulling demand forward or perhaps it was a result of buyer’s reluctance due to the uncertainty regarding the “fiscal cliff” (see the last edition for more on the “fiscal cliff”). More concerning is if there is a larger undefined slowdown due to poor margins, increased competition, excessive volatility and/or a lack of confidence.
While the U.S. automotive sector remains strong and the residential construction industry continues to build momentum in its nascent recovery, manufacturing remained weak overall. In fact, this week the Federal Reserve released their “Beige Book” reporting that “most of the 12 districts saw modest gains in hiring and consumer spending, but manufacturing largely weakened.” While most of Europe’s manufacturing indexes remain in recession way below the 50 point index threshold defining expansion, China, Brazil, India and the U.S. have all reported numbers recently climbing above 50. At closer look though, they are just above 50 and not indicating any significant strength as of yet. James Ryan, CEO of diversified industrial distributor W.W. Grainger, recently said “were not seeing anyone that is stepping out and taking big chances with big projects or large capital investments.”
While I will preface the following with a confession that I have no power to consistently forecast the future with accuracy, I do believe the following scenario is highly likely regardless of an attempt for a third price hike:
China’s over-production/over-supply coupled with declining demand and incorrect speculative bets of massive government stimulus will cause a replay of last summer’s global hot-potato race that turned almost every steel producing country into a net exporter. While China can’t directly dump their steel on U.S. shores, they will have a powerful indirect effect by depressing prices for steel and raw materials in Asia and Europe, especially with respect to what I have referred to as “deflationary attitudes” in past editions of “The Feldstein.” What I mean by this is that as prices start to dip, buyers pull back with concerns that prices for steel and or their products will drop further. Interestingly, this behavior seems to translate across cultures as I have seen it play out this year during the late summer in the Asian iron ore markets and during late September in the U.S. flat rolled markets. As a result, it can be expected that cash will come out of the steel market and mills will need to slash prices to induce buyers. As stated above, I have seen consistent and expanding weakness reassert itself in the Chinese iron ore, rebar and billet markets. Also, I am starting to see evidence of a slowdown in demand occur in the U.S. as hot rolled coil lead times fell to 3 weeks from 3.8 weeks for the period ending on Nov. 18th according to “The Steel Index” among some other anecdotal signs. In the U.S. HRC and Midwest busheling futures contracts, a significant buy imbalance that had prevailed since the initial price increases has begun to erode. Some previous buyers have turned to sellers while prices have slipped $5-$15 over the past couple weeks for Q1 and Q2.