For over a year, this report has held a bullish view based on the following issues:
- Domestic economic and manufacturing strength
- A rebounding and strengthening U.S. energy industry
- Persistently low OEM inventory levels evidenced in the ISM, MSCI and Durable Goods reports
- Steel tariffs and quotas
- Conditions ripe for OEM restocking
- Global economic strength
Recent data and market developments have weakened each of these view points and we now see downside risk to flat rolled prices as significantly higher than upside risk and no longer hold our bullish view.
It appears that the effect of the tariffs and trade war have hampered demand in the manufacturing industry. The October ISM PMI fell to 57.7 and the new orders subindex fell sharply to 57.4 continuing its downtrend. While a 57.4 print for the new orders index is a healthy level, the steep fall and continued downtrend is very concerning.
ISM Manufacturing PMI New Orders Subindex
In addition to the demand destruction resulting from the tariffs (especially seen by smaller and/or under-capitalized OEMs), there has been an increase in domestic production capacity both in the short-term with JSW coming to market and the medium term as additional capacity is set to come on line in 2019.
If new orders continue to decrease, the deficient OEM inventory issue will somewhat be rectified in two ways. First, MOH will increase simply as a function of lower shipments (smaller denominator). Second, the increase in mill production combined with decreased demand will result in a highly competitive market place for mills and service centers with relatively short lead times that provide the ideal environment for OEMs to implement a lean supply chain management strategy.
WTI crude inventory has seen a sizeable build over the past two months…
WTI Crude Oil Inventory
…while the front month crude oil future has dropped 18.4% to $62.21/bbl (as of close 11/6) from a high of $76.24/bbl on October 4. The chart below shows the crude price and the ISM new orders subindex moving together as this significant of a drop in the price of crude indicates not only increased supply as factor, but also could be confirming weaker economic demand.
CME December WTI Crude Oil Future & ISM New Orders Subindex
With the midterm election over and the Republicans losing control of the House of Representatives, we expect President Trump to turn his attention back to trade negotiations. However, the risk profile for the tariffs looks to have flipped from one weighted more heavily toward upside price risk to one weighted more heavily toward downside risk. The weakening economic backdrop in the manufacturing industry, the stock market’s recent slide and perceived loss of power may, and I cannot emphasize the word may enough, have taken some leverage from President Trump to increase the tariffs further. Instead, the highest probability points to an outcome of either the status quo of an ongoing trade war or resolution of the tariffs.
The first development in this regard is likely the reversal of Turkey’s additional 25% tariff on steel as Turkey has released Pastor Andrew Brunson, their currency has moved back down to 5.5 and they have been assisting the U.S. in the investigation of the murder of Washington Post journalist Jamal Khashoggi.
Rising interest rates have also been an economic headwind for residential real estate, automotive sales, businesses and most recently the stock market. Year to date, the average 30 year fixed mortgage rate has risen from 3.85% to 4.82% while the yield on the U.S. ten year Treasury has risen from 2.46% to 3.2%. Interest rates look to continue to rise as the Federal Reserve executes its policy of normalizing interest rates. Disappointing residential housing data has confirmed higher rates have slowed residential purchases over the past few months to some extent.
Bankrate.com 30 Year Fixed National Average (orange) & U.S. 10 Year Treasury Yield (white)
Strengthening global growth was the last component of our bullish view. A number of factors including President Trump’s trade policies, higher interest rates, central bank’s curtailing of monetary easing, politics, currency shifts and perhaps simply the business cycle have contributed to a long and dramatic weakening in the manufacturing PMIs in Europe and Asia since January.
The sharp drop in steel purchase orders that started over the summer labeled as the “buyers strike” resulted in a steep drop in flat rolled prices and lead times. Previously, we expected the pent up or accrued demand from buyers holding off would result in a “short squeeze” higher as three waves of buying would hit the market. The first pushing out lead times and drawing in the second wave, which would further increase lead times and prices. This would draw the third wave of purchases via a short squeeze, where buyers would be forced to pay up for steel as they had through the first six months of 2018. Initially, there was a slight uptick in lead times and slight boost to prices that essentially stymied the drop. However, there has not only been no follow through, but also prices have started to move lower with rumors of deeply discounted tons being discussed across different flat rolled markets. Perhaps the “buyers strike” had less to do with the price and was more an indication of the decreasing growth rates seen in the ISM PMI and other indicators. For now, we believe a prudent and risk-averse approach to the market is the most appropriate until it becomes clear that demand is once again strengthening.
The October ISM Manufacturing PMI dropped 2.1 points to 57.7 and missed the consensus expectation of 59. The ISM PMI is sitting on its three-year uptrend. The Platts TSI Daily Midwest HRC Index fell $2.75 to $830.
ISM Manufacturing PMI (white) and Platts TSI Daily Midwest HRC Index (orange)
The ISM Manufacturing PMI six-month moving average was close to unchanged at 59.3.
ISM Manufacturing PMI Six Month Moving Average (white) & Platts TSI Midwest HRC Index
The October ISM Manufacturing PMI continues to remain in healthy territory; however, a number of subindexes including new orders, production and new export orders fell dramatically.
October ISM Manufacturing PMI
The October ISM Manufacturing PMI printed just below its 2017 level and remains near multi-year highs.
ISM Manufacturing PMI Seasonal Chart
The October ISM new orders subindex fell 4.4 points to 57.4, the lowest level since April 2017. The new orders subindex is trending lower making lower highs and lower lows. This subindex is indicating the demand growth rate is weakening materially and should be closely watched in the coming months. The backlog subindex was flat.
ISM Manufacturing PMI New Orders (white) and Backlog (orange)
This chart adds the new orders and backlog subindexes and is at its lowest level since January 2017.
ISM Manufacturing PMI New Orders Plus Backlog
The chart below shows the producer inventories subindex falling while the customer inventory subindex saw gains, but remains at ultra-low levels. The supplier deliveries subindex was higher, which makes sense considering the convergence of these two inventory subindexes.
ISM Manufacturing PMI Inventory (white) & Customers’ Inventory (orange)
The ISM prices subindex gained 4.7 points to 71.6, which is a bit confusing considering oil prices and steel prices fell throughout October.
ISM Manufacturing PMI Prices (white) & Platts TSI Daily Midwest HRC Index (orange)
This table shows the monthly ISM PMI and subindexes back to October 2017. The new orders, employment and exports subindexes are down YoY while there were YoY gains in supplier deliveries, producer inventories, prices and backlog.
The table below shows the monthly ISM and regional PMIs back to October 2017. All of the indexes, excluding the Dallas Fed Index, are down YoY.
October US light vehicle sales grew at a better than expected 17.5m seasonally adjusted annualized rate (S.A.A.R.).
October US Auto Sales (S.A.A.R.)
The labor market continues to strengthen to historic levels while auto sales remain in a healthy range.
October US Auto Sales (white) and the Inverted Unemployment Rate (orange)
October monthly NSA auto sales totaled 1.36m units and a clear downtrend in sales starting with the high in March has developed.
US Monthly Auto Sales
The seasonality chart below shows October auto sales in line with 2017 and 2016, but below the highs of 2015.
US Monthly NSA Auto Sales Seasonality Chart
This chart shows a three-month moving average of monthly US auto sales at the middle of the range of the past four years.
US Monthly Auto Sales Three Month Moving Average
The three-month U.S. auto sales moving average was flat MoM, but at the lowest level of the past four years.
US 3-Month Moving Average NSA Auto Sales Seasonality Chart
Seasonally adjusted October U.S. construction spending was unchanged MoM, while August spending was revised higher from a 0.1% gain to a 0.8% MoM gain.
September US Construction Spending
Unadjusted September total construction spending was 6.4% higher YoY while YTD spending gained 5.5% YoY.
Unadjusted September total private construction spending was 5.2% higher YoY while YTD spending gained 5.1% YoY.
Unadjusted September private residential construction spending was 4.1% higher YoY while YTD spending gained 6.4% YoY.
Unadjusted September private nonresidential construction spending was 6.7% higher YoY while YTD spending gained 3.5% YoY.
These next two charts show monthly US construction spending back to 2014. September spending (red) dipped slightly MoM, but remains the highest of the past 5 years for both residential and nonresidential.
US Nonresidential Construction Spending
US Residential Construction Spending
Globally, Octobber purchasing manager indexes were mostly lower with 15 countries declining and seven gaining. The U.S. PMI ISM Index fell 2.1 points to 57.7, but remains near the top of the rankings. The JP Morgan Global Manufacturing PMI fell slightly to 52.1, which is the lowest level since November 2016 and has been in a clear downtrend since peaking in December 2017. The PMIs of Italy Taiwan and Turkey are in contraction territory while both of China’s PMIs are just above 50.
The downtrend in European PMIs continued in October. Spain (red) was the only one of the group that saw an increase.
Eurozone (white), German (blue), Italian (green), Spanish (red), and French (yellow) Manufacturing PMIs
The disconnect between Europe’s PMI and the TSI North European HRC price is most likely due to government protections and safeguards, however it has started to fall since peaking in September.
Eurozone (white) and Platts TSI North European HRC Index (orange)
The PMIs of the U.S., Germany and China were all lower MoM.
US (white), German (blue), Chinese (green) and Japanese (red) Manufacturing PMIs
China’s official index continued to move lower, while the Caixan Manufacturing PMI moved up a tick.
China Official (white) and Caixan (orange) Manufacturing PMIs
China’s official PMI continues to trend lower now at the lower end of its five-year range.
China Official Manufacturing PMI (SEAG)
The table below breaks down China’s official manufacturing PMI subindexes. Every category is down YoY.
The Chinese PMI new orders subindex has been trending sharply lower since peaking in May. October’s print is lowest level since February 2016. December Chinese HRC futures fell to a new recent low of $568.43/mt , down $73/t or 11.4% since late August.
China New Orders (white) & Chinese December HRC futures (red)
The two inventory subindexes continued to contract in October.
China Stocks of Finished Goods (white) & Inventories of Raw Materials (red)
Upside Risks:
– Sharp drop in steel imports
– Increased risk of domestic supply disruption
– Further section 232 tariffs and quotas restricting supply
– Chronically low inventory levels
– Chinese economic stimulus measures
– U.S. Infrastructure Bill
Downside Risks:
– 232 exclusions, especially Turkey reverting to original 25%
– Oil price falling dramatically
– Weakening global PMIs
– Falling global flat rolled prices
– Trade War Fallout
– Turkey/emerging market contagion
– Demand destruction due to higher steel prices
– Higher dollar
– Higher interest rates slowing growth
– Increased production & domestic mill reopenings
– Political & geopolitical uncertainty
– Stock Market Crash
Last week, the October CME HRC future fell $8 to $823, while the Platts TSI Daily Midwest HRC Index fell $19.25 to $830.00/st.
October CME HRC Futures (orange) vs. Platts TSI Daily Midwest HRC Index (white)
The CME Midwest HRC futures curve is below with last Friday’s settlements in orange. HRC futures saw some pressure in different points on the curve.
November ferrous futures are listed below.
Flat rolled indexes were mostly lower.
The AISI Capacity Utilization Rate rose to 81%.
AISI Steel Capacity Utilization Rate and TSI Daily HRC Price
Last week’s latest October flat rolled import license data is forecasting a MoM increase of 113k tons.
Last week’s October tube import license data is forecasting a MoM increase of 112k tons.
October combined flat rolled and tube import licenses are forecasting a 225k ton MoM increase.
Flat Rolled (blue) and Tube (red) Imports
October AZ/AL import licenses are projecting a slight decrease MoM to 76k tons.
Galvalume Imports (blue) w/ 3 Mo. Moving Average (red)
Below are HRC and CRC Midwest vs. each country’s export price differentials using pricing from SBB Platts. Differentials have been decreasing in recent weeks mostly due to Midwest indexes falling.
SBB Platt’s HRC, CRC and HDG WoW pricing is below. US Midwest HRC and CRC were down 0.6% and 1.6%, respectively. Houston HDG prices fell 4%. Brazilian HRC jumped 12.5%, while Mexican CRC dropped 9.7%.
Price changes of ferrous raw materials are below with scrap gaining and ore falling sharply WoW. Midwest shred gained $19.30 or 5.6% to $360.80/lt. East Coast Shred and busheling each gained around 2.5%. The SGX 2M Ore future fell 5.4% and the IODEX dropped 3.8%.
The November SGX iron ore future fell $2.03 or 2.7% to $72.76, while November Turkish scrap gained $2 or 0.6% to $339.
November SGX Iron Ore Future (Left) & November LME Turkish Scrap Future (Right)
The SGX iron ore futures curve has rallied over the last month with the front of the curve steepening.
The chart below shows the SGX 2nd month iron ore future breaking above its long term down trend, but last week’s significant drop has put the rally in question.
SGX 2nd Month Ore Future
Ex-flat rolled prices were mostly unchanged except the January Chinese rebar future, which fell 3.3%.
Most of last week’s economic data has already been covered above. The employement report continues to show a strong economy with a better than expected addition of 250k nonfarm payrolls and 32k manufacturing jobs. The unemployment rate held steady at 3.7% while the labor force participation rate ticked up to 62.9% from 62.7%. The September Durable Goods Report indicated a 0.7% gain in new orders and no change MoM in new orders for goods ex-transportation. Captial goods orders fell slightly MoM. September factory orders ex-transportation gained 0.4% MoM and August’s data was revised higher. The Case-Shiller 20-City Home Price Index rose 5.49% YoY, but missed expectations of a 5.8% gain. The Core Personal Consumption Expenditures Index gained 2% YoY.
U.S. Durable Goods New Orders Total
Inverted U.S. Unemployment Rate
U.S. Manufacturing Payrolls N.S.A.
The S&P 500 rose 2.1% WoW tempering its recent slide for now. The other equity markets on the list also rebounded.
S&P 500
Steel mill stocks all rebounded sharply WoW led by Gerdau and US Steel both gaining almost 9%.
US Steel
Service center’s stocks were mixed with Commercial Metals gaining 15.5%, while Ryerson saw a 3.7% decline.
Commercial Metals
Equities of iron ore miners saw sizeable gains.
BHP Billiton
LME base metal’s prices were mixed with a 2% gain in copper, while zinc fell 3.8% WoW.
CME December Copper Future
LME 3-Month Rolling Zinc Future
The U.S. dollar continued to rally last week gaining $0.18 to $96.54, while the yen fell 1.15%. The Turkish Lira gained 3%, while the Mexican peso fell 3.4%.
US Dollar Index
Japanese Yen
Turkish Lira
The November WTI crude oil future fell $4.45 or 6.6% to $63.14/bbl. Crude oil inventory added 0.8%, while gasoline inventory fell 1.4% and distillate inventory fell 3.1%. The aggregate level decreased of 0.5%. Crude oil production inched up to a new high of 11.2m bbl/day. The US rig count fell by one rig and the North American rig count lost three rigs. The November natural gas future rose $0.10 or 3.1% to $3.28/mbtu. Natural gas inventory rose 1.6% to 3.14 trillion cubic feet.
Dec. WTI Crude Oil Future (orange) and Dec. Crude 15 Delta Put Volatility (white)
Aggregate Energy Inventory (white) vs. Dec. 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 gained fourteen basis points closing the week at 3.21% and the German ten-year rose by eight basis points closing the week at 0.43%.
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 highly likely.
Upside Risks:
– Sharp drop in steel imports
– Increased risk of domestic supply disruption
– Further section 232 tariffs and quotas restricting supply
– Chronically low inventory levels
– Chinese economic stimulus measures
– U.S. Infrastructure Bill
– 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:
– 232 exclusions, especially Turkey reverting to original 25%
– Oil price falling dramatically
– Weakening global PMIs
– Falling global flat rolled prices
– Trade War Fallout
– Turkey/emerging market contagion
– Demand destruction due to higher steel prices
– Higher dollar
– Higher interest rates slowing growth
– Increased production & domestic mill reopenings
– Political & geopolitical uncertainty
– Stock Market Crash
– Crashing iron ore, scrap and finished steel prices
– Domestic automotive industry under pressure
– Sharp and persistent drop in oil and/or iron ore prices
– 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