I am anxiously awaiting next month’s U.S. macroeconomic data to see if July’s weakening data was simply a pause in what has otherwise been a stellar year for manufacturing or the beginning of a downtrend in the economy.  However, last week a number of bullish developments for the steel industry unfolded.  First, the No. 3 blast furnace at ArcelorMittal’s Indiana Harbor plant was shut down after a large bell was dropped into it during a charge and the furnace is expected to be down two weeks.  Then, Brazilian steelmaker Usiminas was forced to temporarily halt operations at its Ipatinga mill Friday.  The two incidents are eerily reminiscent to a string of production accidents that occurred in early 2014 that tightened that market through year-end. 

Last, and most significant was President Trump’s announcement to double of tariffs on steel imported from Turkey that took effect Monday, August 13th.

In the June 8th Week-Over-Week, it was noted that the price of tariff-adjusted Turkish steel had become attractive, but…

Another important consideration is the following condition at the end of the 232 Investigation recommendation memo:

Any exclusions granted (to other countries) could result in changed tariffs or quotas for the remaining products to maintain the overall effect”


That is, they can raise tariffs for other countries or products if they choose at any time.  

So, it wasn’t as much of a surprise as some may think.  Regardless, it is an unequivocal supply constraint.  Also, this policy change dumps more uncertainty on to the market. 

  • What will happen to the tons already in transit to the U.S?
  • What about the tons already produced, but not shipped? 
  • What about the tons ordered but not produced. 
  • Whether you assume that 100% of these three buckets or some large percentage of those that are never delivered, what is the reaction by those who had placed those orders?  Some of those tons will be place with domestic mills at a time when mills are much more willing to negotiate and lead times have noticeably softened.  Last week’s developments could push lead times back up and embolden domestic mills as they head into contract season. It is likely that those who move first and fast this week will get the best deals until enough volume is ordered and then flat rolled prices will make a jump higher.

    Turkey’s economy is in a perilous position evidenced by the crisis in their currency, which traded as low as 7.2 lira to the dollar last Sunday.  Concerns of collateral damage and contagion will be sorted through this week.  The risk that the financial chaos in Turkey bleeds into other markets triggering something more serious or crimping confidence must be considered.  

    Turkish Lira

    LME Turkish scrap futures, which had been in decline, began rapidly selling-off last Friday.  Purchases of East Coast U.S. scrap will surely fall as well.

    LME 2nd Month Turkish Scrap Future

    Weakness in emerging markets has been slowly percolating as many of these countries see their dollar denominated debt burdens increase as U.S. interest rates and the US dollar rise.  The focus was on Turkey, but keep your eye on the Chinese yuan, which closed the week just under 6.85.

    Chinese Yuan

    As discussed last week, China had responded to US tariffs by stimulating their economy with lower interest rates, a weaker yuan and a significant infusion of new loans.  In fact, the increase in June new yuan loans exceeded the increase in aggregate financing (size of the banking industry), which led to the conclusion that the excess was from the People’s Bank of China (P.B.O.C).  July’s new yuan loans increased by 1.45 trillion yuan ($213b), beating expectations of an increase in 1.275b yuan.  Moreover, new yuan loans exceeded aggregate financing again in July, this time by $60b. New yuan loans have exceed aggregate financing by almost $215b cumulatively from May through July.  This is simply quantitative easing. 

    Chinese Monthly Change Aggregate Financing (red) & New Yuan Loans (white) (Billion Yuan)

    Considering China’s long-term policy focus/objectives, paranoia over the mistakes (reforms/Perestroika) made by the U.S.S.R. that led to the downfall of the communist party’s there, President Xi’s consolidation of power in recent years and these aggressive financial moves/quantitative easing, it is clear that the Chinese are more worried about their bigger picture.  In response, they are taking aggressive and proactive measures to fight back.  The Chinese only have to wait out President Trump at best two years and at worst six.    A long protracted trade war that slows U.S., Chinese and global economic growth is likely.  At first blush, it would seem that the U.S. has the upper hand as China’s largest customer, but after reflecting on it, the Chinese probably have the upper hand with time on their side and a mountain of cash to weather the strorm.

    Cumulative YTD Aggregate Financing (white) & New Yuan Loans (red) (Billion Yuan)

    However, in the short term, those billions of dollar of quantitative easing should pump up Chinese HRC and rebar prices.  The futures continue to rally as the factors discussed above are already having an effect.

    Shanghai Futures Exchange October Chinese HRC and Rebar Futures (yuan)

    Looking at the PBOC’s balance sheet, you see a spike in assets over the few past months, which connects all the dots above.  The consequences of these actions are uncertain, but could be powerful.  First, these actions show the Chinese are taking a proactive approach to the tariffs and trade war sending the message they are hunkering down and ready for a fight.  Increased rhetoric from the Trump administration indicates they got the message.  Second, this stimulus will result in increased demand in China’s economy, most likely in the old economy, and that will likely lead to global commodity inflation in the months ahead.  Third, if the trade war with the U.S. is resolved in the short term, this stimulus will add fuel to the recent simultaneous global economic expansion.  However, perhaps China will have to tighten the spigot in response.  Last, this further increases China’s already extremely levered up economy.  Could this trade war lead to the unintended consequences of pushing China’s economy to the brink?  These questions offer very different and opposing outcomes and therefore significant uncertainty.  What other responses are to come from the world’s two largest economies?  

    People’s Bank of China Total Assets

    The following issues are the foundation of our current bullish view:

              Steel tariffs and quotas

              Domestic economic and manufacturing strength

              A rebounding and strengthening US energy industry

              Persistently low OEM inventory levels evidenced in the ISM, MSCI and Durable Goods reports

              Conditions ripe for OEM restocking 

              Global economic strength

    Upside Risks:

    –          Sharp drop in steel imports

    –          Increased risk of domestic supply disruption

    –          Section 232 tariffs and quotas restricting supply

    –          Chronically low inventory levels

    –          USW September contract negotiations

    –          Chinese economic stimulus measures

    Downside Risks:

    –          Trade War Fallout

    –          Turkey/emerging market contagion

    –          232 exclusions

    –          Nafta Resolution

    –          Stock Market Crash

    –          Demand destruction due to higher steel prices

    –          Higher dollar

    –          Higher oil prices slowing growth

    –          Higher interest rates slowing growth

    –          Domestic mill reopening

    –          Falling iron ore and scrap prices

    –          Political & geopolitical uncertainty 

    Last week, the August CME HRC future added $7 to $901/st, while the Platts TSI Daily Midwest HRC Index dropped $2.5 to $901.25/st.

    August CME HRC Futures (orange) vs. Platts TSI Daily Midwest HRC Index (white)

    The CME Midwest HRC futures curve is shown below with Friday’s settlements in orange.

    September global ferrous futures are listed below.  Turkish rebar and scrap fell sharply.  U.S. shred and busheling followed.

    Flat rolled indexes were mostly lower, but none by more than 1.6%.

    The TSI North European HRC Index was down €0.50 WoW to €565/t. The TSI ASEAN HRC Index was down $2 to $598/t.

    The AISI capacity utilization rate slipped slightly to 78%.

    AISI Steel Capacity Utilization Rate and TSI Daily HRC Price

    July’s flat rolled forecast looks to increase to just over 1m.  August’s forecast is to fall back to 917k.

    July’s tube imports look to increase to 629k, but then forecast to fall back to 554k in August.

    Flat Rolled (blue) and Tube (red) Imports

    July’s galvalume import licenses forecast is for a jump to 90k, but then to fall back to 55k in August.

    Galvalume Imports (blue) w/ 3 Mo. Moving Average (red)

    Below are HRC, CRC and HDG prices and differentials using pricing from SBB Platts.  Differentials are coming off new highs in HRC, while they failed to break to new highs in CRC.   

    Prices adjusted for tariffs paint a much different picture however.  The following charts compare the normal differentials from above with the tariff adjusted differentials i.e. Midwest HRC – (1.25 x China Export) plus any AD/CD duties from recent trade cases except China’s 250% tariffs were not included in the math as they prohibit any imports, but the Chinese export price can still be used as a proxy for the rest of Asia.  The charts below compare the current tariff adjusted differentials (red line) to where it would be on their historical unadjusted charts (blue line), Brazilian and Russian steel remains unattractive.  Chinese and therefore Southeast Asian HRC prices are approaching the high end of their range.  Turkish HRC has been a buy since June and license data has been indicating an increase in HRC Turkish tons, but then Trump increased the tariff on Turkish steel to 50%.  The charts below show the differential between Midwest HRC and Turkish import HRC prices in blue, the same differential including the 25% tariff in red and the chart on the right adjusts for the 50% tariff.  The increased tariff should provide a much needed shot in the arm to domestic demand as the not only has the Turkish outlet been turned off, but all of the tons that were about to arrive and on order must now be diverted back to another supply source. 

    How flat rolled imports play for the rest of 2018 will be interesting to see.  Issues related to year-end taxes and to a smaller extent the risk of additional tariffs or other defensive measures that could be taken by the Trump administration and D.O.C. are the primary considerations when purchasing imported tons. The window for year-end delivery is closing fast; however, some are expecting imports will have a significant effect on Q1 2019 purchases with Q1 HRC futures trading around $800, $100 below spot. 

    The SBB Platts HRC, CRC and HDG pricing is below.

    Coking coal and iron ore prices rallied, while scrap prices were under pressure.

    The September LME Turkish scrap future fell $25 or 7.5% to $308/t, while the September SGX iron ore future gained $1.40 or 2.1% to $69.1/t. 

    The SGX iron ore futures curve has rallied in the past month, but has mostly maintained its shape.

    The chart below shows the 2nd month SGX iron ore had broken below its longterm up trend.  The “triangle” pattern predicts a significant correction to result, but the correction failed to materialize and instead rebounded back into the triangle moving higher along with the rally in finished Chinese steel futures.

    2nd Month SGX Ore Future

    Ex-flat rolled prices were mixed.

    Chinese iron ore and rebar inventory declined slightly, while HRC inventory rose by 2%.

    Steelhome China Iron Ore Total Ports Inventory

    Steelhome China HRC Total Inventory

    Steelhome China Rebar Total Inventory

    Steelhome China 5 City Combined Finished Inventory

    All of last week’s economic releases are listed below with the most notable the CPI Ex-Food & Energy which rose 2.4% YoY, beating expectations.  The PPI Ex-Food & Energy rose 2.7%, just missing expecations of 2.8%. 

    The S&P 500 was close to unchanged, while the VIX Index jumped after reaching ultra-low levels followed by  concerns regarding Turkey and emerging market turmoil.  China’s markets rose, while stock markets in Japan and Europe moved lower.

    S&P 500

    Steel mill stocks moved lower as concerns over growth….trumped the doubling of tariffs on Turkish steel. 

    US Steel

    Service center’s stocks were mixed.

    Worthington Steel

    Iron ore miners were lower.

    LME base metals were mixed with aluminum and nickel up nicely, while zinc fell 3.2%.

    LME 3-Month Rolling Zinc Future

    LME 3-Month Rolling Aluminum Future

    The US dollar rallied to 96.36 breaking out of its multi-month range.  The Turkish lira fell a whopping 26.6% and the euro fell 1.3% to 1.14 along with it.  The Brazilian real and Russian ruble were also down significantly.

    Turkish Lira

    US Dollar Index

    Russian Ruble

    Brazilian Real

    The September WTI crude oil future fell $0.86 or 1.3% to $67.63/bbl.  Crude oil fell slightly, but there were builds in distillate and gasoline inventory levels, which resulted in a small increase of the aggregate inventory level.  Crude oil production fell slightly to 10.8m bbl/day.  The US rig count added 13 rigs while the North American rig count cut one. The August natural gas future gained $0.09 to $2.94/mbtu while inventory rose 2% to 2.35 trillion cubic feet.

    September WTI Crude Oil Future and Sept. Crude 15 Delta Put Volatility (white)

    Aggregate Energy Inventory (white) vs. WTI Crude Oil Futures

    D.O.E. Crude Oil Inventory

    D.O.E. Crude Oil Inventory Perspective (1982 – Present)

    Baker Hughes US Rig Count

    Baker Hughes North American Rig Count

    D.O.E. Crude Oil Production

    D.O.E. Crude Oil Production Perspective (1983 – Present)

    The US ten-year Treasury yield settled the week down eight basis points to 2.87%.  The German ten-year yield fell nine basis points or 22% in reaction to Turkey.  

    U.S. Ten-Year Bond Yield

    German Ten-Year Bond Yield

    The list below details some upside and downside risks relevant to the steel industry.  The bolded ones are occurring or look to be highly likely.  The upside risks look to be in control.

    Upside Risks:

    –          Sharp drop in steel imports

    –          Increased risk of domestic supply disruption

    –          Section 232 tariffs and quotas restricting supply

    –          Chronically low inventory levels

    –          USW September contract negotiations

    –          Chinese economic stimulus measures

    –          Potential Russian sanctions cutting off Russian steel

    –          China strict steel capacity cuts/China getting serious about curtailing steel production

    –          Energy industry rebound

    –          Graphite Electrode Shortage

    –          Unexpected inflation

    –          Weaker dollar

    –          Flatbed trucking availability/transportation supply constraints

    –          Infrastructure bill/long-term solution to highway spending bill

    Downside Risks:

    –          Trade War Fallout

    –          232 exclusions

    –          Nafta Resolution

    –          Demand destruction due to higher steel prices

    –          Higher dollar

    –          Higher oil prices slowing growth

    –          Higher interest rates slowing growth

    –          Domestic mill reopening

    –          Falling iron ore and scrap prices

    –          Political & geopolitical uncertainty 

    –          Crashing iron ore, scrap and finished steel prices

    –          Stronger dollar

    –          Sharp increase in scrap volumes resulting from Hurricanes Harvey & Irma

    –          Domestic automotive industry under pressure

    –          Sharp and persistent drop in oil and/or iron ore prices

    –          US domestic producers bringing back on capacity

    –          Higher interest rates slowing residential construction and auto sales

    –          Tightening financial conditions pressuring auto sales driven by sub-prime financing

    –          Chinese restrictions in property market

    –          The Chinese Financial Crisis

    –          Unexpected sharp China RMB devaluation

    –          Increasing import differentials

    –          Economic downturn, especially in China or Europe reverberating to U.S.A.

    –          Weak demand in housing or automotive