Two weeks have gone by since the most recent spate of steel price increase announcements and there have been some positive developments. Lead times have stopped falling and have increased slightly. The sub $800 deals appear to have disappeared. Most importantly, we have seen a solid number of purchase orders hit FGM’s books with the second week exceeding those in the first week following the increase. One of our assumptions is that FGM is a proxy for the rest of the service center industry so if we are getting a rebound in purchase orders, so are other service centers and that will translate into orders for the mills in due time. We are paying close attention to mill lead times and the calendar as we are weeks away from lead times falling into January 2019.
The “buyer’s strike” that lasted for over two months looks to have been behaviorally driven and that behavior was positively reinforced week after week as prices and lead times consistently fell. While it looks like this initial round of price increases resulted in a return to more normal purchasing levels, not enough has occurred to shift buyer’s mentality away from this risky lean inventory/just-in-time purchasing strategy and toward restocking.
Another bullish development is on the raw materials front where scrap and iron ore prices have rallied strongly this month. Also, don’t forget about President Trump’s influence on the steel industry and the power and willingness to use that power to adjust tariffs at will.
However, evaluating if there will be a resumption of the rally or if the market will continue to fall has not been more difficult all year.
A rise in interest rates has had a negative impact on the residential construction industry and the economy. The stock market is in the midst of a sharp correction with the S&P 500 falling 11.5% from its high of 2944.75, which was reached only weeks ago on October 3.
S&P 500
This chart shows the difference between the yield of a basket of high yield corporate bonds and the yield on the U.S. 10-year Treasury bond. When investors flee risk assets, they tend to move capital into risk free Treasury bonds. This is an excellent gauge of professional investors risk aversion. This chart shows the differential expanding to the highest level since December 2016. This is happening in concert with the equity sell-off over the past couple weeks, however the chart shows, in perspective; it’s only a blip…so far. However, there are major negative implications if the market correction turns into a full-blown crash.
BarCap US Corp. High Yield YTW – 10-Yr. Treasury Spread
As part of the equity sell-off there has been a general risk-off mentality, which has driven oil into the mid-60s, a very bad sign for the steel industry crude continues lower. Further, crude oil inventory, shown below, is showing signs it could start to head higher, which will further pressure oil prices lower.
D.O.E. Crude Oil Inventory
There is tremendous uncertainty surrounding the economic outlook following the outcome of next week’s mid-term election. The Trump administration will certainly get back into trade negotiations and perhaps start moving closer to resolving the tariffs placed on steel and aluminum. This could include a reduction of tariffs on Turkish steel back to 25% in return for the release of Pastor Andrew Brunson. Additionally, another round of tariffs on Chinese goods have been threatened by the POTUS. The Chinese yuan has been reacting in kind nearing 7 yuan to the dollar and China has been reducing their holdings of U.S. Treasury bonds as part of strategy to weather the economic burden of the tariffs. These increased trade tensions and moves by the Chinese have resulted in the devaluing of the yuan, strengthening of the dollar, weakening of commodities, etc. and this is deflating the animal spirits unleashed following President Trump’s election win. Whether this is transitory or a shift in trend will be closely watched and analyzed in this report over the coming months.
The following issues are the foundation of our current bullish view:
- 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
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 Strike at ArcelorMittal
Downside Risks:
– Trade War Fallout
– Turkey/emerging market contagion
– Reversal of Turkish steel tariffs to 25%.
– 232 exclusions
– 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
– Increased domestic production
– Political & geopolitical uncertainty
The November CME HRC future gained $23/st to $834 while the Platts TSI Daily Midwest HRC Index dropped $4.75 to $832.75/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. The curve rose with the increase in the HRC index.
November ferrous futures are in the table below. Most of the group saw gains led by LME Turkish scrap up 6.5% and LME rebar up 3.6% WoW.
Flat rolled indexes were mostly unchanged except Black Sea and North European prices falling close to 2%.
The AISI Capacity Utilization Rate dipped slightly to 80% from 80.2% last week.
AISI Steel Capacity Utilization Rate and TSI Daily HRC Price
We forecast a slight MoM increase in flat rolled import licenses with October at 1.05m tons vs. 1.03m in September.
We forecast a 11.7% increase in October tube licenses to 543k from 486k in September.
October flat rolled-plus-tube import licenses are forecast a 69k ton increase MoM.
Flat Rolled (blue) and Tube (red) Imports
AZ/AL import licenses look to continue to hover around the 80k ton level again in October.
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.
SBB Platt’s HRC, CRC and HDG WoW pricing is below. The Chinese export and domestic HRC price fell 2.37% and 1.4%, respectively. HRC prices in South Europe, East Asia (import) and Turkey (export) were down 2.8%, 1.8% and 1.3%, respectively.
Chinese CRC prices fell with domestic down 2.7% and export down 1.7%. South Europe CRC was down 1.9% WoW.
Prices for North and South European HDG fell 3.3% and 2.2%, respectively.
Raw materials saw further gains with the IODEX up 4.8% and Turkish scrap up 2.1%.
The November SGX iron ore future gained $3.26 or 4.6% while the November Turkish scrap future gained $20.50 or 6.5% to $337.
The SGX iron ore futures curve:
The chart below shows the 2nd month SGX iron ore future breaking out of a “triangle” pattern, which predicts a significant rally to come.
2nd Month SGX Ore Future
Ex-flat rolled prices are below.
September preliminary durable goods orders ex-transportation were increased by 0.1% missing expectations, but August data was revised higher. The October Richmond Fed. Manufacutring Index fell to 15 from 29 in Septemeber and missed expectations. The Kansas City Fed Manufacturing Index fell five points to 8 and missed expectations.
The September New Homes Sales report was downbeat falling 5.5% MoM and August’s data revised lower. September pending home sales alsofell sharply with downward revisions for August’s data.
Stock markets sold off across the globe as higher interest rates and worse than expected economic data and earnings reports continued to roll in. The S&P 500 fell 3.5% while Korea’s market was down 6% and the Nikkei fell 5.5%.
S&P 500
Steel mill stocks were all down, except for Gerdau. AK Steel was down 14.2%, ArcelorMittal fell 10.5%. US Steel and Steel Dynamics were down around 6.5%.
AK Steel
Service centers were all down on the week led lower by Reliance Steel, which was down 6%.
Reliance Steel
Equities of iron ore miners have continued to slip despite the rally in iron ore.
Zinc Futures were the only base metal to rise last week gaining 1%. Nickel fell by 4.4% and copper futures were down around 1%.
LME 3-Month Rolling Nickel Future
The U.S. dollar added 0.7% to $96.36 near the highs seen in August. The British pound fell 1.9% and the Euro fell 1%. The Brazilian real gained 1.9% to the highest level since May.
US Dollar Index
Brazilian Real
British Pound
Volatility was up sharply across the board with vol. on 10yr Treasury and the S&P futures up 22.2% and 19.1%, respectively.
The November WTI crude oil future dropped $1.53 or 2.2% to $67.59/bbl. Crude oil inventory added another 1.5%, while gasoline inventory fell 2.1% and distillate inventory was down 1.7%. The aggregate inventory level was close to unchanged. Crude oil production was flat at 10.9m bbl/day. The US rig count added one rig while the North American rig count added ten rigs. The November natural gas future fell by $0.06 or 2% to $3.19/mbtu. Natural gas inventory rose 1.9% to 3.1 trillion cubic feet.
Dec. WTI Crude Oil Future (orange) vs. Dec. Crude 15 Delta Put Volatility (white)
Dec. WTI Crude Oil Future (orange) vs. Aggregate Energy Inventory (white)
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 12 basis points closing at 3.08% while the German 10-year fell 11 basis points to 0.35% as investors ran for cover with equity markets under intense pressure. The Barclays High Yield – U.S. 10-Year Treasury Yield differential jumped 35 basis points to 3.79%, the highest since December 2016.
BarCap US Corp. High Yield YTW – 10-Yr. Treasury Spread
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 prompts 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 Strike at ArcelorMittal
– 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
– Turkey/emerging market contagion
– Reversal of Turkish steel tariffs to 25%.
– 232 exclusions
– 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
– 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