The purpose of this report is to analyze the upside and downside risks to U.S. flat rolled prices; to evaluate the significance of each and the balance of these risks in aggregate. For over a year, upside risk has significantly outweighed downside risk. Last week, this report withdrew its bullish view due to the deterioration of these 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
Not only have the issues above weakened dramatically or reversed, but also these downside risks listed below have been gaining momentum recently and that has significantly increased downside risk.
– Declining rates of growth in manufacturing and tariff induced demand destruction
– Weakening global economics
– Crude oil prices falling sharply
– Higher interest rates
– Strengthening U.S. dollar
– Falling global flat rolled prices
– Tariff resolution
– Increased domestic production capacity
The October ISM PMI fell to 57.7, still at a solid level, but the trend is indicating a decrease in the rate of growth. The ISM PMI is sitting right on its up trend line that started in December 2016 at the same time as the start of the multi-year rally in flat rolled. If the ISM moves lower next month, it will break below this trend.
ISM Manufacturing PMI
The ISM Manufacturing PMI new orders subindex is also showing a clear downtrend from its peak of 67.4 from last December making lower highs and lower lows.
ISM Manufacturing PMI New Orders Subindex
2017 was characterized by collective global strength in manufacturing. This peaked at the turn of the year and has steadily moved lower since.
J.P. Morgan Global Manufacturing PMI
China’s Official Manufacturing PMI new orders subindex has fallen to the lowest level since September 2016.
China New Orders PMI
As of Tuesday November 13, the December WTI crude oil future has fallen 27.7% from its high on October 3! This could be indicative of weakening global demand as well as the obvious increased supply, but regardless, the result is likely a drop in rigs. Expect a decrease in steel demand for OCTG and other products if this occurs. Keep an eye on the rig count.
CME WTI Crude Oil Future
The downtrend in global manufacturing PMIs started at the beginning of the year and then accelerated in the spring. Perhaps this is due to the business cycle or perhaps President Trump’s trade policy, but regardless of the reason, a broad based steep drop in commodity prices started a few months after U.S. tariffs on steel, aluminum and China took effect in July continues to make new lows.
In 2018, 30-year mortgage rates have increased from 3.8% to 4.8%. On a 200k mortgage, that results in an increase of $117/m. On a 400k mortgage, that results in an increase of $235/m. Is that enough of an increase to change a potential new home buyers mind? Residential sales data has disappointed over the past few months, so it looks to be a drag. Higher interest rates also are a headwind for businesses, especially those tied to short-term rates, such as service centers.
Bankrate.com 30-Year Mortgage Rate
The U.S. dollar has rallied to the highest level since June 2017. Typically, a higher dollar pressures commodity prices (globally priced in dollars) lower as non-dollar denominated buyers have to come up with more currency to purchase U.S. goods. Moreover, the advantageous currency exchange rate makes exporting goods to the U.S. more attractive.
U.S. Dollar Index
As indicated above, Chinese spot HRC has fallen 12% to $559/mt. Using this as a proxy for HRC prices in Asia, that translates to $508/st and tariff included to $635/st. Add $100 for freight and profit to get $735 delivered. This could be where the US market is headed, assuming Chinese prices don’t continue lower. Keep in mind that China is still under prohibitive duties in excess of 200% to export to the U.S., but the Chinese number is indicative of prices in Asia and drives pricing globally. Moreover, the upside price risk that President Trump further increases tariffs cannot be forgotten, however this power may be diminished slightly by the democrats gaining power of the House, but mostly because of the some of the weakness seen in the manufacturing economy and stock market.
Chinese Domestic HRC Spot
Case in point, similar to the Chinese HRC price, the Platts TSI US Midwest HRC Index has fallen sharply since July.
Chinese Domestic HRC Spot USD/mt (orange) & Platts TSI Midwest HRC Index (white)
With AISI utilization levels at highs not seen since 2008, additional tons already coming on line at JSW (1.5m annual) and Granite City (2.2m annual) plus additional capacity from the likes of Nucor, SDI, Big River and NLMK potentially totaling as much as 6m annualized tons, a drop in demand will result in a massive drop in the HRC price. This downside risk needs to be recognized as a major downside risk.
AISI Steel Production Capacity Utilization Rate
The “buyer’s strike” that started in July dominated the flat rolled market until Nucor announced a price hike last month. This thesis assumed that steel buyers refrained from purchasing tons first in response to a $900+ HRC price and then to consistent week after week drops in prices and lead times. Given recent information, one has to consider that perhaps this buyer’s strike was not exclusively due to these dynamics, but also in response to a slowdown in new orders. This report assumed that the accrued deficit of tons that weren’t purchased by OEMs during those months would eventually have to be bought. That the OEMs would be caught short on inventory and this would result in a bottleneck in orders and spike in lead times and flat rolled prices. However, new evidence from the September durable goods report that showed a drop in shipments and the drop in October’s ISM Manufacturing PMI and new orders subindex could be indicating that the inventory levels are instead adjusting to falling demand. It is too soon to tell, but too many signals are flashing red. Shifting a cautious approach is prudent until more information is available.
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 November CME HRC future fell $11 to $812, while the Platts TSI Daily Midwest HRC Index fell $8.50 to $821.50/st.
November 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.
December ferrous futures are listed below.
Flat rolled indexes were mostly lower led by Chinese Spot HRC down 3.2%.
The AISI Capacity Utilization Rate rose to 81.8%, the highest since 2008.
AISI Steel Capacity Utilization Rate and TSI Daily HRC Price
Last week’s latest November flat rolled import license data is forecasting a MoM increase of 180k tons.
Last week’s November tube import license data is forecasting a MoM increase of 85 tons.
November combined flat rolled and tube import licenses are forecasting a 351k ton MoM increase.
Flat Rolled (blue) and Tube (red) Imports
November AZ/AL import licenses are projecting an increase to 101k tons MoM.
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. HRC Differentials saw an uptick over the previous week, while CRC Differentials continued the downward trend.
SBB Platt’s HRC, CRC and HDG WoW pricing is below. US Midwest HRC and CRC were down 1% and 0.9%, respectively. The Russian HRC export price fell the most by 5.2%. Southern European HDG prices fell 1.3%.
Price changes of ferrous raw materials are listed below. The IODEX gained 4.3% and SGX 2-month iron ore futures rose 3.7%. The Baltic Dry Index fell 16.3% or $239 to $1,231 WoW!
The December SGX iron ore future rose $2.6 to $73.40, while the December Turkish scrap future fell $3.50 to $330.
December SGX Iron Ore Future (Left) & December LME Turkish Scrap Future (Right)
The SGX iron ore futures curve has rallied over the last month with the front of the curve steepening and the back of the curve falling.
The chart below shows the SGX 2nd month iron ore future breaking above its long term down trend. The rally looked to have stalled falling back the week before last; however, the rally resumed gaining $2.6 WoW.
SGX 2nd Month Ore Future
Ex-flat rolled prices were mostly gained with the January Chinese rebar future leading the way up 7.4% on the week.
Below is last week’s economic data. The big news on the week was the Fed decision to leave rates unchanged at 2.2%.
The S&P 500 rose 2% WoW. TheChina CSI 300 was the only other notable mover falling 3.6%.
S&P 500
Steel mill stocks mostly fell WoW led by Gerdau and AK Steel both down over 7%. Nucor, however, rose 3.7%.
Service center’s stocks are below. N.W. Pipe was up 23%, while Commercial Metals saw a 4.7% decrease.
Commercial Metals
Equities of iron ore miners all fell in spite of last week’s gains in ore futures. Cleveland Cliffs and Vale decreased by the most of the falling 8.4% and 5.5% respectively.
Cleveland Cliffs
LME base metal prices were all down WoW led by copper and nickel.
LME 3-Month Rolling Copper Future
LME 3-Month Rolling Zinc Future
The U.S. dollar continued to rally last week gaining $0.36 to $96.91, while the Ruble fell 2.7%.
US Dollar Index
Japanese Yen
Russian Ruble
Turkish Lira
The December WTI crude oil future fell $4.67 to $60.19/bbl, but Natural Gas Futures saw a 13.25% increase WoW. Crude oil inventory added 1.4% and gasoline inventory added 0.8%, while distillate inventory fell 2.7%. The aggregate level gained 0.5%. Crude oil production continued on to a new high of 11.6m bbl/day. The US rig count grew by 14 rigs and the North American rig increased by 12.
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 fell by 3 basis points closing the week at 3.18%, while the Italian ten-year rose by eight basis points closing the week at 3.40%.
U.S. Ten-Year Bond Yield
Italian 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