- Additional easing from Bank of Japan and Bank of England; Well received Spanish bond auction.
- Shipping conditions improve on River Danube and potential strike from International Longshoremen’s Associated averted by three month contract extension.
- Chinese steel prices stable this week.
- Some positive news in the residential housing industry.
- Downward momentum in hot rolled coil and scrap prices continues; short-term deflationary expectations beginning to take hold with lead times falling off a cliff and significant increases in steel mills willingness to negotiate.
- Numerous supply side adjustments announced through project shutdowns and layoffs.
- Strongly negative comments by executives at BHP, FedEx and Dow Chemical regarding China’s economic growth.
- Sluggish demand, over-production of steel and over-supply of iron ore continues in China.
- Chinese steel trading scandal expanding. Current estimates of $785 million in bad debt among Shanghai steel traders; banks react. Shanghai Futures Exchange raises margin requirements.
- Unrest in China: Obama vs. China in WTO dispute and Chinese/Japanese tensions flare up over land dispute.
- Poor economic numbers – U.S. jobs below expectations, U.S. and Chinese manufacturing numbers still indicating contraction.
Central Bank Stimulus Isn’t Enough….
While additional easing was announced this week from the B.O.J. and B.O.E., the euphoria over global monetary easing and economic stimulus subsided as markets began to realize the bad economic news and missed expectations are here to stay for at least the short to intermediate term. China’s economic slowdown has resulted in sluggish steel demand that has led to collapsing iron ore, coal and rebar prices. What is puzzling aboutChina, which accounts for half of global steel production, is their staunch resistance to any meaningful cuts in production. In fact, this weekChina’s crude steel production rebounded to an average of 1.89 million tons per day. “Production could increase further in mid-September as a result of the steel price recovery triggered by China’s approval of new infrastructure projects and U.S. quantitative easing,” (SBB 9/18/12). The oversupply of steel has led to short-term deflationary expectations that are starting to spread globally; more on this below.
While the stimulus announcements provided a brief respite for prices late last week and early this week, heavily volatile trading brought prices of iron ore, rebar and coal back down at the end of the week with iron ore finishing down 2.4%, rebar up 1% and coking coal down 1.6% for the week. According to The Steel Wire, “total iron ore inventories at the 30 largest Chinese ports dropped by 420,000 tons last week to a total of 95.5 million tones.” This week, BHP Billiton’s chief commercial officer Alberto Calderon’s made the following comments: “Chinese iron ore demand has slowed by more than half its usual pace. We’re already seeing the beginning of the end of the first phase of economic development in China…What we have seen the past ten years is not only a function of massive demand coming from China but the industry not being prepared. This won’t be repeated. Margins will still be good but the scarcity pricing we won’t see again, on average.” (Bloomberg 9/15/12). Additional negative comments regarding China’s economy from the CEO’s of FedEx and Dow Chemical followed.
If that isn’t enough though, there is more. Do you remember a few weeks back stories of steel warehouses defrauding banks and investors by pledging their steel to multiple lenders? Now, “Chinese authorities discovering that several steel traders had used steel as collateral that was pledged to multiple lenders or often found that the steel being used as collateral never existed in the first place…the practical implication is that this should make things far more difficult for steel traders to obtain loans collateralized with warehouse receipts…indeed some lenders have already suspended acceptance of these receipts out of concerns that they could be forged or that the steel could be pledged to multiple lenders. Current estimates of about $785 million in bad debt amongst Shanghai steel traders alone suggest that the rally has weaker legs than many analysts have suggested,” (TSW 9/17/12). It is typical to see frauds arise following price corrections and crashes. As Warren Buffet says, “Only when the tide goes out do you discover who’s been swimming naked.” Don’t be too surprised if this story gains steam and the $785 million grows quickly. By the way, the Shanghai Futures Exchange said it would temporarily raise margins for all its futures contracts. Since there is a buyer and a seller for every future, this move effects both sides equally, however if one side has more leveraged speculators on it, those traders will have to come up with more capital or liquidate their positions, which could lead to a negative feedback loop potentially sending prices lower once again.
If that still isn’t enough negativity though, there is still more. The Japanese government agreed to buy several islands from a private Japanese citizen, but those islands are in dispute and claimed by the Chinese. This has led to an escalating geopolitical feud between the two countries resulting in Chinese demonstrations, violence against Japanese business operations in China and reports of Chinese patrol ships in the vicinity of the disputed islands. Oh, and there is a trade war brewing as accusations by President Obama to the WTO alleging China is providing illegal subsidies to automobile and auto part exporters. Perhaps this is just a political move from the administration, but the slowing of trade between China and Japan and/or the U.S. does not fare well for any of the parties involved.
China’s slowdown is having a significant global effect on the steel and raw materials industries. Announcements of supply side adjustments to the slowdown were rampant last week. BHP Billiton, Fortescue Metals, Hebei Iron & Steel, Severstal, Northern Iron, Arch Coal, Alpha Natural Resources and Cline Mining Corporation all announced closure of expansion projects, current operations and/or layoffs etc. in response to plummeting iron ore and coal prices as well weakening steel prices. While this might be helpful to the tightening of future supply, in the short-term, the layoffs and lost production will be a negative drag.
In the U.S., hot rolled coil prices in the physical market are falling fast with anemic lead times and rumors of mills willing to negotiate getting louder. “Buyers told SMU there continues to be a lot of “uncertainty” in the market and from both the service centers and manufacturing companies we are learning of a new wave of inventory reductions as buyers anticipate being able to procure steel at ever lower prices in the coming weeks,” (SMU 9/18). Only 5% of North American companies expect prices to rise in the next three months, according to the latest carbon steel market survey results from The Steel Index (TSI). The real danger to HRC prices here is that the short-term deflationary expectations we’ve seen wreaking havoc in the Chinese steel market creep into the domestic HRC market leading to buyers delaying orders or purchasing on a as need basis. The potential for a negative feedback loop to develop as mills break ranks and chase orders offering incentives and lower prices has heightened.
Scrap prices are moving lower as well. “Despite a recent flourish of Turkish mill buying activity from the US East Coast, scrap suppliers are still bracing for another drop in domestic scrap prices for October requirements…sources expect diminished US steel mill appetite for scrap to drive down prices for the second consecutive month,” (SBB Daily Briefing 9/20/12). “Facing declining sentiment in the domestic scrap market and falling export prices to Turkey, US East Coast docks have once again lowered their buying price for ferrous scrap,” (SBB 9/21).
On top of that, “J.P. Morgan analysts downgraded several steel-related stocks to “neutral” from “overweight,” saying weak steel demand undercuts the share’s prospects.,” (WSJ 9/18). “The AISI reported yesterday that July was an especially tough month for steel shipments from US producers. US mills shipped out just over 7.9 million net tons of steel, down 1.3% from the month prior though still a strong improvement over last years’ July shipments which were at just 7.4 million net tons. Despite the 6.8% year on year growth, the mills are still not as profitable as they would like to be… So far in 2012 through July mills have shipped a total of 52,189.307 tons, which is a very solid 11.2% increase year on year. This seems to indicate that going forward we will have to expect that shipments will continue to trend lower for August and probably September as well. (SW 9/19). Last week was particularly tough for equities in the steel and raw materials industries.
Manufacturing numbers from the U.S. and China are still showing weakness and the U.S. jobs report was disappointing. Nevertheless, U.S. is still showing strength in the some sectors, especially automotive and some good number came out of the nascent recovery in the residential housing sector. While the collective stimulus should have a real positive effect on global economies in the coming months, we will have to struggle through a horde of bad economic news for the time being.