Picture yourself barreling down a black diamond on a pair of skis in Vail at 40 mph when you unexpectedly catch the edge of one of your skis. Suddenly, you are acutely aware of nothing in the world except that you are about to fall into a painful yard sale followed by a long slide down a steep icy slope.
That brief moment depicts the feeling in the domestic HRC market in the last week of January as the futures market came of recent highs in the face of an AK Steel led price increase followed by most other mills. The futures reflect this dip in confidence. Below is the shift in the HRC curve from January 6th (green) to February 6th (orange).
CME Midwest HRC Futures Curve
Keeping with the analogy, the catalyst for catching your ski’s edge was the sharp drop in Turkish scrap prices, which fell 22% in three weeks!
TSI Turkish Scrap Index Through February 1st
While many were attributing the sharp drop in scrap to a quickly devaluing Turkish lira, a shortage of domestic rail cars might be to blame. The rail car shortage forced some scrap collectors to abort West Coast shipments. Instead the scrap was sent to the East Coast and exported at fire sale prices. Turkish scrap prices have rebounded somewhat since the first of February.
TSI Turkish Scrap Index
Last week, news and rumors that domestic mills were seeing an influx of energy related RFQs and new orders in addition to the bounce in scrap calmed the industry’s nerves and prices stabilized. Revisiting our analogy above once again, you were able to catch and stabilize yourself. Yard sale avoided! The steel rally continues!
But don’t forget, you’re still on a double black diamond so focus!
In addition to the news above, last week gave us insight into manufacturing, auto, construction, energy and employment data, which all continue to be positive.
Data supporting our thesis that the domestic steel industry will see a bounce back in demand this year with potential for a sharp restocking rally is explained below. Current fundamentals lead us to believe that any sell offs will be shallow and short lived. Upside price risk is much greater than downside risk due to the current relatively low inventory levels being held across the supply chain.
The January ISM Manufacturing PMI reached a new recent high of 56, up 1.5 points vs. December and beat expectations.
ISM Manufacturing PMI
The chart below shows the ISM PMI vs. the rolling 2nd month HRC futures. I will let you make your own conclusion on why I am spending so much time on the ISM.
ISM Manufacturing PMI vs. 2nd Month Midwest HRC Futures
New orders were rock solid at 60.4 while prices have now reached a nose bleeding 69. The table below includes the ISM sub-indexes.
January ISM Manufacturing PMI
Producer and customer inventory sub-indexes both in contraction at 48.5 are respectively characterized by the ISM as “contracting” and “too low.” This is a theme discussed here regularly and a potential catalyst for a restocking rally to take place at some point.
ISM Manufacturing PMI Business and Customer Inventories
The sharp decline seen in MSCI service center flat rolled inventory correlates with ISM inventory data.
The backlog sub-index at 49.5 when the new orders sub-index is above 60 is a bit perplexing.
ISM Manufacturing PMI New Orders (White) and Backlog (Orange)
So I looked at the each month’s backlog sub-index minus the respective month’s new orders index and produced the mean reverting chart below (red line is the mean).
I went back 20 years and looked at each of the first instances where the difference was -10.5 or less (I excluded the 2nd and 3rd consecutive months when there was one).In all of those instances, the backlog sub-index gained in the months that followed. I examined each rally and noted the data below using the high point of the rally measure
While far from being statistically significant, on average, every instance saw an increase in the backlog with an average 11.8 increase in the backlog. New orders were close to unchanged on average. The length of each rally lasted between 2 and 12 months.
I repeated the process above except this time included the consecutive months in the data set and only looked at the change in the backlog three months after the month where the backlog-new order differential was -10.5 or below.
In this data set, backlogs increased 7.14 points on average while new orders were unchanged on average.
The conclusion is look for backlogs to improve over the next couple months.
Below you can see the ISM and ISM sub-indexes back to December, 2015. Notice:
1. The backlog sub-index is 10.9 points below the new orders sub-index
2.Inventories and customer inventories are too low
3. Manufacturing is much improved year-over year
So expect backlogs to increase and demand to remain positive.
A Bloomberg analyst estimates an increase of 4m short tons of total steel demand for every $100 billion in infrastructure spending. Consider MSCI flat rolled data showed shipments falling 2% in 2016. Mean reversion, President Trump’s fiscal stimulus plans and a rebounding energy market point to the potential for a nice rebound in domestic steel demand in 2017.
The table below includes the regional manufacturing reports showing a stark improvement versus data from this time last year. Notice the Dallas and Kansas City reports, two regions highly dependent on the energy industry showing major year-over-year improvements.
U.S. Manufacturing Reports
As noted above, the energy industry is clearing improving with a strong uptrend in U.S. rig counts now at 729. Not only does this translate into demand for pipe and tube, but also railcar manufacturing.
Baker Hughes US Rig Count
It also means more jobs.
US Employees Nonfarm Payrolls Total SA
Nonfarm payrolls gained 227k new jobs in January crushing expectations. Hourly earnings missed expectations, but improved 0.1%. The average work week was much improved in construction and was up slightly in manufacturing. The unemployment rate fell slightly to 4.8%.
The first thing to do when you get a new job is to get a car. Auto sales just missed expectations and were down from December, but still remain at very strong levels.
US Auto Sales SAAR
January sales were a bit weak falling 1.7% YoY.
Most troubling was a big jump in inventory levels; especially at the big three.
Construction spending fell 0.2% MoM SA and missed expectations, however private nonresidential remains very strong.
Most importantly, the uptrend continues.
Below is country by country January PMI data with the left table sorted high to low and the right table sorted by geography.
Below is the same data as above, but focused on the more steel intensive countries. All in all, the data is in good shape and improving.
Below is China’s PMI with sub-indexes and interestingly looks similar to the US ISM PMI data showing an improving index, strength in prices and new orders with weak backlogs and long-term contraction in inventory levels.
The takeaway from all this data with respect to the steel market is that it is showing demand is strong across the board. The construction, auto and energy industries, which account for 80% of domestic demand, can all be characterized as strong and/or improving.
China returned from the Chinese New Year holiday to find a massive jump in ferrous inventory levels, especially in iron ore. While the big jump in rebar levels is a seasonal phenomenon in line with previous years, the new highs in iron ore are worrisome and iron ore prices responded by falling 6% to close the week.
After China announced that their foreign reserves fell below $3 trillion earlier this week, iron ore futures caught a bid and moved back up above $80/t. This might seem backwards, but it is all tied to Chinese stimulus decisions and the property market. The market’s response looks to be expecting that China will back off plans for constricting stimulus and increasing property restrictions.
Chinese Foreign Reserves
US flat rolled prices remain in orbit of the $630 level. North European HRC gained another $9/st while Black Sea HRC slipped $5.
HRC futures fell $17 in March, but rebounded in the back half of the year.
March CME HRC Futures vs. TSI Daily Midwest HRC Price
Import data continues to be weak with the fall in HRC imports eye-opening. HRC imports averaged 238k st per month in 2016. January is forecast to be 143k tons below this monthly average.
AISI Steel Capacity Utilization Rate and TSI Daily HRC Price
Utilization and production put up some decent gains.
Midwest shred fell $30/lt last week in response to the sharp fall in Turkish scrap. Iron ore futures fell 6% as China returned from the Chinese New Year to new highs in iron ore inventory levels. Busheling fell almost 4% and Black Sea pig iron fell 3.5%.
The iron ore curve remains backwardated through 2017 and has dropped MoM.
Chinese rebar futures fell in concert with iron ore.
December factory orders rebounded gaining 1.3%. December pending home sales gained 1.6% beating expectations of a 0.6% gain. December core PCE prices were up 1.7% YoY, unchanged MoM. The January ISM Services Index ticked down to 56.6, below expectations of a gain to 57. January Consumer Confidence slipped to 111.8, but remained at very healthy levels.
The S&P was flat while China, Europe and Japan saw some selling.
Steel mills were mostly lower while service centers were mostly unchanged.
Iron ore miners all sold off with ore.
Base metals were mixed. Nickel gained almost 8% while zinc and aluminum gained. Copper fell 2%.
The dollar index broke below 100 with the Japanese yen taking most of the gains. The Turkish lira rebounded 4.5% while the Mexican peso, Korean won, Australian dollar, Russian ruble and Indian rupee gained at least 1%.
US Dollar Index
WTI crude oil futures gained 1.24% even as the aggregate inventory level gained over 1%. Rig counts continue to build, however, production slipped. Natural gas dropped sharply due to the mild winter weather.
WTI Crude Oil Futures
Aggregate Energy Inventory 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
D.O.E. Crude Oil Production
D.O.E. Crude Oil Production Perspective (1984 – Present)
The US ten year bond yield remained in the 2.4 – 2.5% range. German and British bond yields fell while Spanish and Japanese bond yield rose. Inflation expectations continue to move higher with five year expectations at 2.05%.
U.S. 10 Year Bond Yield
The list below details some upside and downside risks relevant to the industry. The bolded ones are occurring or look to be highly likely. Upside risks look to be in charge.
– Big rally triggered by price increases/low inventory/restocking
– President Trump’s agenda
– Energy industry rebound
– Infrastructure bill/long-term solution to highway spending bill
– China getting serious about curtailing steel production
– Transportation supply constraints
– Essar labor issues
– Post-election economic pick up
– Massive restocking (domestic and/or global)
– Unplanned domestic supply side disruptions
– China pumping up its “old economy”
– The Chinese Financial Crisis
– China RMB devaluation
– Rebound in import volumes
– Increasing import differentials
– Resumption of US dollar rally/currency issues/sovereign default
– Higher interest rates slowing residential construction and auto sales
– Tightening financial conditions pressuring auto sales driven by sub-prime financing
– Oil and/or iron ore slide
– U.S. (manufacturing) recession
– Falling ferrous raw materials and global finished steel prices
– US domestic producers bringing back on capacity
– Economic downturn, especially in China or Europe reverberating to U.S.A.
– Weak demand in housing or automotive