I left the SMU Conference concerned that demand destruction at OEMs could be a major issue going forward; that this was the primary reason behind the weakness seen in July’s economic data and throughout the industry in August. I was expecting Tuesday’s announcement of the August ISM Manufacturing PMI to fall. Not only did it not fall as expected, but the ISM Manufacturing PMI rose to the highest level, 61.3, since 2004.
Nevertheless, steel prices and domestic lead times continue to fall. July data shows service centers grew their inventory levels via both domestic mill purchases and imported tons, while shipments remained at a very strong level. August’s ISM PMI confirms that demand remains strong and indicates shipments should stay at high levels. In addition to the ISM, construction spending and auto sales continue to be solid while the energy industry continues to roar.
As we have been searching for an explanation to the weakening flat rolled prices and lead time issues, the most obvious reason was simply that it was the slow month of August. A more complete explanation might be due to the month-to-month lumpiness of service center orders. We know service centers took in a good deal of tons in July and perhaps this slowed the group’s purchases in late July and August. Domestic mills lead times started to shrink. Initially a couple mills started offering discounted prices. Shorter lead times eased the availability issues faced by OEMs with low inventory levels. Buyers, both OEM and service centers, saw prices falling and stopped buying. This “buyers strike” has become the buzzword of late and has perpetuated the cycle lower. However, all of this steel will need to be purchased at some point.
However, the economy remains strong. The statistics are very good! Unemployment at 3.9%, Q2 GDP at 4.2%, Q3 GDP predicted at 4.4%, the ISM Manufacturing PMI at 61.3 and the ISM Non-Manufacturing PMI at 58.5.
In the steel industry, August flat rolled imports look to be down 19% MoM or 200k tons. The AISI Capacity Utilization Rate stands just below 80%. The United Steelworkers unanimously approved authorization for their leaders to call for a strike. There has not only been no resolution to the tariffs, but the administration came close to an agreement with Mexico over what will become of NAFTA and there was nothing in that deal about removing the tariffs. Expect more of the same, especially heading into the midterm elections.
The pent up buying is waiting on the sidelines and will fuel the next leg of the rally.
At some point, the discounts will be low enough that large orders will be place and once that order volume has been reached, poof all those deals will be gone and the next price will be $50 higher as all of that pent up demand resurfaces.
Don’t delay buying by reaching for a little bit more of a deal. You don’t want to miss the boat.
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
The August ISM Manufacturing PMI rose 3.2 points to 61.3, the highest reading since 2004 crushing expectations of a fall of 0.5 points to 57.6. The Platts TSI Daily Midwest HRC Index fell $1.50 to $881.
ISM Manufacturing PMI (white) and Platts TSI Daily Midwest HRC Index (orange)
The ISM Manufacturing PMI six-month moving average rose slightly to 59.15.
ISM Manufacturing PMI Six Month Moving Average (white) & Platts TSI Midwest HRC Index
The August ISM Manufacturing PMI showed a strong robust rebound across the subindexes with new orders, production and backlog the strongest of the group. The new orders, production, supplier deliveries and prices subindexes were all above 60. Producer inventory rose to 55.4, while customer inventory rose slightly to 41, which is the 23rd consecutive month this subindex has been in contraction. The idea that any selloff in price will be short lived and the play is to buy the dips has worked throughout these almost two years that customer’s inventories have been too low. Nothing looks to have changed on this front.
August ISM Manufacturing PMI
August’s reading of 61.3 is the highest since 2004 when the ISM reached 61.4, making it the second highest reading in at least 30 years (yellow line is at 61.3).
ISM Manufacturing PMI
This chart shows the ISM on a seasonal basis comparing August PMIs back to 2013.
ISM Manufacturing PMI Seasonal Chart
The new orders and backlog subindexes showed a sharp rebound in August.
ISM Manufacturing PMI New Orders (white) and Backlog (orange)
This chart adds these two subindexes, also showing a sharp rebound.
ISM Manufacturing PMI New Orders Subindex Plus Backlog Subindex
The chart below shows the producer and customer inventory subindexes rebounding with the customer inventory sub index mired in contraction.
ISM Manufacturing PMI Inventory (white) & Customers’ Inventory (orange)
Despite the strength in new orders and backlogs, the ISM prices subindex fell 1.1 points to 72.1, which is still a very strong print historically.
ISM Manufacturing PMI Prices (white) & Platts TSI Daily Midwest HRC Index (orange)
The table below shows consistent strength in the PMI and subindexes back 13 months.
The table below shows the monthly ISM and regional PMIs back to August 2017.
The colors in the table above correspond with the appropriate PMI index below. The data continues to show a broad based uptrend, except in the region governed by the Philadelphia Fed.
Seasonally adjusted US auto sales fell to a 16.6m unit annualized rate in August and missed expectations of a 16.8m S.A.A.R.
August US Auto Sales SAAR
This long-term chart inverts the unemployment rate to show the strong correlation between employment and auto sales. Based on this data, strength in auto sales should continue to oscillate between 16m to 18m annualized units as long as the current near full employment level continues.
August US Auto Sales (orange) and the Inverted Unemployment Rate (white)
Non-adjusted August auto sales of 1.47m were up 8.4% MoM and basically unchanged YoY.
US Monthly NSA Auto Sales
US Monthly NSA Auto Sales Seasonality Chart
The unadjusted auto sales three-month moving average was down 2.6% MoM, but up 0.7% YoY. Year-to-date, 11.42m units have been sold, up 1.1% vs. 2017.
US Monthly Auto Sales Three Month Moving Average
US 3-Month Moving Average NSA Auto Sales Seasonality Chart
Seasonally adjusted July U.S. construction spending rose 0.1% MoM, missing expectations of a 0.4% gain, but June’s spending was revised higher to a 0.8% decrease from a 1.1% decrease. Seasonally adjusted spending rose 8.8% YoY.
July US Construction Spending
Unadjusted July total construction spending was 6.5% higher YoY while YTD spending gained 5.2% YoY.
Unadjusted July total private construction spending was 6.2% higher YoY while YTD spending gained 5.2% YoY.
Unadjusted July private residential construction spending was 8.7% higher YoY while YTD spending gained 7.8% YoY.
Unadjusted July private nonresidential construction spending was 2.9% higher YoY while YTD spending gained 2.2% YoY.
Unadjusted July total nonresidential construction spending was 4.9% higher YoY while YTD spending gained 3.5% YoY.
These next two chart show monthly US construction spending back to 2014. July (red) continues to gain YoY and is the highest of the past 5 years for both.
US Nonresidential Construction Spending
US Residential Construction Spending
The JP Morgan Global Manufacturing Index fell 0.2 points to 52.5. The countries/regions with gains vs. drops was 12 to 13. Australia saw a sharp gain of 4.7 points to 56.7, Switzerland gained 3.2 points to 64.8 and both South Korea and Russia gained some ground in fighting to get back above 50. Turkey’s PMI fell further into contraction dropping 2.6 points to 46.4 as their financial troubles continue to escalate. Italy and Mexico saw their PMIs fall by over a point at just above 50. Vietnam’s PMI fell 1.2 points to 53.7, while Indonesia’s rose 1.4 points to 51.9.
The downtrend in Eurozone PMIs continued in August with France and Spain the only two not seeing their PMIs fall. Germany’s PMI fell a full point to 55.9.
Eurozone (white), German (blue), Italian (green), Spanish (red), and French (yellow) Manufacturing PMIs
The TSI North European HRC Index has remained steady (in US dollar terms too), despite the downturn in the Eurozone’s PMI. European safeguards greatly helped to prop up the index.
Eurozone PMI (orange) and Platts TSI North European HRC Index (white)
The ISM PMI jumped big in August, while the PMIs in Germany, Japan and China were down or flat.
US (white), German (blue), Chinese (green) and Japanese (red) Manufacturing PMIs
The Caixan Manufacturing PMI has steadily been trending lower since spring.
China Official (red) and Caixan (white) Manufacturing PMIs
China’s August PMI at 51.3 is second to only 2017.
China Official Manufacturing PMIs
The table below breaks down China’s official manufacturing PMI subindexes. There’s very little change MoM. The Input price subindex is the lone standout jumping to 58.7 from 54.3.
There was almost no change in new orders nor was there much movement in the prices of Chinese spot hot rolled and the TSI ASEAN HRC index.
China New Orders (white), TSI ASEAN HRC Index (red) & Chinese Spot Price (blue)
China Stocks of Finished Goods (white) & Inventories of Raw Materials (red)
Last week, the September CME HRC future dropped $5 to $861/st while the Platts TSI Daily Midwest HRC Index fell $1.5 to $881/st.
September 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.
Flat rolled indexes were mixed.
The TSI North European HRC Index gained $5.31 WoW to $662/t. The TSI ASEAN HRC Index was down $2 to $597/t.
The AISI Capacity Utilization rate took a breather falling 20 basis points to 79.3%.
AISI Steel Capacity Utilization Rate and TSI Daily HRC Price
July’s official flat rolled imports rose 155k tons MoM to 995k. August’s flat rolled imports forecast is for a fall to 145k tons to 851k.
July’s official tube imports rose 57k tons to 571k. August’s tube import forecast is to fall 52k back to 519k.
July’s flat rolled plus tube imports were 1.57m. August import licenses are forecasting a drop back to 1.37m.
Flat Rolled (blue) and Tube (red) Imports
July’s galvalume imports rose 17.6k tons to 94.6k. August licenses are forecast to fall 34k tons to 60.7k.
Galvalume Imports (blue) w/ 3 Mo. Moving Average (red)
Below are HRC, CRC and HDG prices and differentials using pricing from SBB Platts. Differentials have been decreasing in recent weeks.
Tariff adjusted prices continue to indicate imports will remain be relatively depressed through year end. The following charts compare the normal differentials from above with the tariff-adjusted differentials. For instance Midwest HRC – (1.25 x China Export) + (AD/CD duties) is the red line (except China’s 250% tariffs were not included in the math as they obviously prevent 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).
Turkish HRC had been a buy starting in June, but then Trump increased the tariff on Turkish steel to 50%. The charts below show the historical differential between Midwest HRC and Turkish import HRC prices in blue and the Turkish import price adjusted for the 50% tariff in red. The increased tariff will provide a boost to domestic demand likely prohibiting Turkish tons for the rest of 2018.
Chinese/Southeast Asian HRC price differentials have moved back to the middle of the range. Brazilian and Russian steel remains unattractive.
How flat rolled imports playout for the rest of 2018 will be interesting to see. Following the increase in Turkish tariffs, the risk of additional tariffs or other defensive measures for any country could be taken by the Trump administration and D.O.C. must be considered more carefully and should result in decreased imported tons. The window for 2018 delivery is practically closed. Imports are expected to fall into year end.
The SBB Platts HRC, CRC and HDG pricing is below.
Turkish scrap rebounded while Midwest shred was down 7%.
The September LME Turkish scrap future added $5 or 1.6% to $310/t, while the September SGX iron ore future fell $0.26 or 0.4% to $66/t.
The SGX iron ore futures curve has sold off and flattened in the past month.
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. Then that rally failed and we moved back below the uptrendline. Ore volatility is ultra-low.
2nd Month SGX Ore Future
Ex-flat rolled prices were mixed.
On the economic front, Second quarter GDP beat expectations increasing to 4.2% annualized growth and beating expectations of a 4% annualized gain. The most recent third quarter GDP forecast from the Atlanta Fed’s GDP Now rose to 4.4%.
Home prices increased by 6.3% YoY in June according to the Case-Shiller 20-City Home Price Index. July pending home sales fell 0.7% MoM, missing expectations of a 0.3% MoM gain. July’s unadjusted pending home sales fell 0.5% YoY, beating expectations of a 2.5% drop.
July’s core Personal Consumption Expenditures Index rose 2% YoY, in line with expectations.
The S&P 500 was making new highs last week. Equities were higher in Asia and down in Europe.
S&P 500
Steel mill stocks were mixed.
US Steel
Service center’s stocks were also mixed.
Olympic Steel
Ore mining stocks were mixed.
LME base metals were mostly lower with zinc falling hard. Zinc extras are being decreased at domestic mills as zinc has fallen almost 33% from its highs.
LME 3-Month Rolling Nickel Future
LME 3-Month Rolling Zinc Future
CME December Copper Future
LME 3-Month Rolling Aluminum Future
Currencies were quiet with the US dollar close to unchanged, except the Turkish lira, which saw a sharp almost 9% move lower on the week.
Turkish Lira
US Dollar Index
Australian Dollar
The October WTI crude oil future gained $1.08 or 1.6% to $69.8/bbl. Crude oil, distillate and gasoline inventory levels all declined. The aggregate inventory level fell 0.6%. Crude oil production was flat at 11m bbl/day. The US rig count added 4 rigs and the North American rig count added 3 rigs. The October natural gas future was unchanged at $2.92/mbtu, while inventory rose 2.9% to 2.5 trillion cubic feet.
October WTI Crude Oil Future (orange) and Nov. Crude 15 Delta Put Volatility (white)
Aggregate Energy Inventory (white) vs. WTI Crude Oil Futures (orange)
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 five basis points higher to 2.86%.
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