Last week’s WoW report covered the September PMIs, September auto sales and August construction spending.  If you missed it, check our website where all of the WoW reports are archived. 

The last time BOTH the ISM Manufacturing and Nonmanufacturing Reports were above 59.5 was January, 2004. 

ISM Manufacturing Report (white) & Nonmanfacturing Report (Orange)

As horrible and tragic as the hurricanes of 2017 were, their destruction is and will continue to create a significant boost in demand across a wide array of industries including, but not limited to, steel, manufacturing, automotive, demolition, waste disposal, recycling, repair services, restoration services, residential construction, nonresidential construction, heavy machinery, architecture, engineering, legal, insurance, energy, retail, home furnishings, appliance, etc., etc. etc. etc. 

The jump in the ISM survey’s are the first indication of a potential wave of demand to hit the economy over the coming months.

Throughout the year, this report has asserted service center flat rolled inventory levels and OEM inventory levels are too low evidenced by not only the MSCI report, but also the ISM and Durable Goods Reports and this low inventory will lead to a restocking rally.

In last week’s WoW report, data from the August Durable Goods Report was examined finding that inventory levels continued to be depleted in August by subtracting the YoY change in new orders from the YoY change in inventory. 

To be clear, if a surf shop had 100 surfboards on the floor in August, 2016 and 105 surfboards in August, 2017, inventory has increased 5% YoY.  However, if you have an 10% YoY increase in new orders, ie orders to buy 10 surfboards, then by the end of August, your inventory will end up being down YoY because there isnt enough inventory to cover the new orders.

100 surfboards +  5 surfboards – 10 surfboards = 95 surfboards

This week takes this analysis one step further adjusting for seasonality by comparing August, 2017 data versus data in each of the the past twenty five Augusts back to 1992. 

For instance, taking the YoY % change in inventory (Column E) minus the YoY % change in new orders (Column D) for the “total” durable goods category in 2017 shows a draw down of 2.7% (Column C). The twenty five year average of the YoY % change in inventory minus the YoY % change in new orders for the “total” durable goods category in the month of August shows an average inventory drawdown of 1.3% (Column B).  Taking Column C – Column B shows a drawdown in August of 2017 of 1.4% greater the 25 year average. 

Inventory in the primary metals category is down 7.2% YoY, thats 6.3% below the long run August average of a 0.8% drawdown.

Inventory in the fabricated metals category is down 5.5% YoY, thats 4.5% below the long run August average of a 1% drawdown.

Inventory in the capital goods category is down 5.2% YoY, thats 3.9% below the long run August average of a 1% drawdown.

This data in concert with the low flat rolled inventory data in the MSCI and the chronic contraction in the ISM customers’ inventory sub index, most recently at an anemic 42, provides overwhelming and irrefutable evidence that the inventory levels are too low and these levels are unsustainable.  

While the current micro cycle and downbeat sentiment in the steel industry calls this conclusion into question, the success in the buying the dips strategy is grounded in these tight inventory levels. 

The timing and catalyst for a restocking is next to impossible to predict and is a fool’s errand anyway.  However, if this restocking event occurs under current conditions, predicting a bottleneck in the supply chain that will cause flat rolled prices to rocket higher can be predicted to have a high probability with confidence.  

The Midwest HRC price continues the rally that began in December, 2015 at $365/st.  After correcting 10% from the $660 high set on March 20th, 2017, the TSI Daily Midwest HRC Index has bounced off a low of $591 closing this past week down $7 to $610, while the October CME Midwest HRC future was up $5 to $604.  

The damage caused by the 2017 hurricane season should boost steel demand in the months ahead as totaled autos are replaced and communities are rebuilt.  September auto sales were fantastic helping alleviate recent concerns over falling auto demand seen throughout 2017.  Globally, manufacturing PMIs continue to strengthen with the US now up to 60.8. The energy industry continues to regain strength as crude prices hover around $50/bbl and US production has rebounded above the high levels seen just prior to Hurricane Harvey.

Flat rolled import licenses continue to fall sharply while global flat rolled differentials remain unattractive leading to expectations of tighter supply over the short and medium term.  According to an article in last week’s Steel Market Update, almost 800k flat rolled tons will be affected by fourth quarter domestic mill maintenance shutdowns. 

Further, Chinese government officials issued orders this week for fourteen steel mills in Hebei province’s Handan city to cut blast furnace utilization rates to 45-50% starting October 1st until March 31st, 2018.  SBB Platts estimates this will curb 62k crude steel tons per day. 

While global and domestic steel industry fundamentals remain strong, some cracks to the bull case have emerged.  Iron ore and scrap prices continue to be under serious pressure.  This has in turn pressured finished steel prices lower.  The domestic market has been sluggish not only due to falling raw materials, but also what looks to be an overhang of imported tons delivered in Q2 and Q3, most of which was in anticipation of a potentially restrictive 232 ruling.  Last, a nascent rally in the US dollar is worth watching as a stronger dollar can pressure commodity prices lower.  

November CME HRC Futures vs. TSI Daily Midwest HRC Price

Data continues to show persistently low inventory levels at OEMs and service centers.  Current conditions are ripe for a massive restocking rally. 

The following are the foundation of our current constructive view:

  –     A global uptrend in manufacturing purchasing managers indexes

  –     A rebounding US energy industry

  –     Persistently low flat rolled inventory evidenced in the MSCI, ISM and Durable Goods reports

  –     Conditions ripe for distribution and customer restocking 

  –     Falling imports volumes expected for the remainder of 2017; shrinking global differentials

Upside Risks:

–        China strict steel capacity cuts/China getting serious about curtailing steel production

–        Low inventory levels/domestic or global restocking

–        Post hurricane development and production bump

–        China pumping up its “old economy”

–        Energy industry rebound

–        Graphite Electrode Shortage

Downside Risks:

–        Crashing iron ore, scrap and finished steel prices

–        Political & geopolitical uncertainty

–        Stronger dollar

–        Sharp increase in scrap volumes resulting from Hurricanes Harvey & Irma

The table below compares the percentage changes of a cross section of steel related raw materials and finished products since June 1st.  Midwest HRC continues to be at the bottom of the list and previously we expected US prices would move higher catching up with the other products, but instead scrap has sold off sharply. The two prices are converging.  Asian HRC, coking coal, copper and iron ore continue to hold on to most of their gains while China returns from last week’s Golden Week holiday.

As of Friday’s settlement, the October CME Midwest HRC future settled up $5 to $622/st.  October was down $6 to $599.  November was down $3 to $602 and December was flat at $605.  Q1 2018 gained $5 to $607 and Q2 2018 gained $8 to $610. 

Flat rolled prices were mostly lower with only the TSI ASEAN gaining on the week.

The TSI ASEAN HRC Index was up $7 to $517/st, while the TSI North European HRC Index shed $1 to $577/st.

Imports look to have peaked and are rolling over as expected.

Flat Rolled (blue) and Tube (red) Imports

Flat rolled imports looks to have definitely peaked and are trending lower.

Tube imports have exploded this year, but may have peaked in July.  The chart below includes the drastically revised September forecast of 768k tons.

Below are HRC, CRC and HDG prices and differentials using pricing from SBB Platts.  HRC and CRC differentials remain near multi-year lows.  The lack of deals made in the May through July period due to the Section 232 Investigation and now the closing of the import price window supports our belief that imports will decline precipitously in the near term and stay depressed until early 2018 at the earliest.

HRC prices were mixed with Brazilian Export falling almost 4% and Indian HRC gaining almost 4%.  The Midwest HRC price continues to slowly decay losing almost 1% t to $610/st.

CRC prices saw pressure in Brazil and Mexico.

Chinese Domestic HDG fell almost 5% and Chinese exports shed 1.5%.  The US Midwest HRC price was down 1.2% while European prices gained over 1%.

AISI Steel Capacity Utilization Rate and TSI Daily HRC Price

The AISI capacity utilization rate fell again last week to 73.2%.

Midwest shred and busheling settled last week reflecting the sharp fall we had already seen in the higher frequency scrap prices.  Those higher frequency scrap products and iron ore gained 1.5-2% on the week.

Iron ore and scrap futures rebounded last week.

The iron ore curve has shifted lower MoM with the curve flattening.

OCTG fell along with US plate, Black Sea billet and Turkish rebar.

The final August Durable Goods Report improved even fruther with orders up 2%, durable goods orders ex-transportation up 0.5% and capital goods orers nondefense ex-aircraft up 1.1%.

The August factory orders gained 1.2% MoM, beating expectations of 1%.  August factory orders ex-transportation gained 0.4% MoM.

The September Nonfarm Payroll Report showed a decrease of 33k jobs vs. expectations of 80k, while July’s data was revised higher to 169k from 156k jobs. The unemployment rate fell to 4.2% beating expectations of 4.4%.  The labor participation rate rose to 63.1% from 62.9% and beat expectations of no change.  Average hourly earnings saw nice gains rising 0.5% MoM beating expectations of 0.3% and rising 2.9% YoY beating expectations of a 2.6% rise.  August hourly earnings were revised higher as well.

September US Unemployement Rate

September Average Hourly Earnings Growth YoY

The September ISM Nonmanufacturing report shot up to 59.8, crushing expectations of 55.5. 

The S&P 500 made another new all-time high closing the week at 2545.1.  Europe and Japan moved up as well.  China was closed.

S&P 500

Steel stocks were mixed.  Service center stocks fell sharply.

Steel Dynamics

Ryerson

RIO and BHP gained.

Copper, aluminum and zinc gained over 2%.

CME December Copper Future

LME 3 Month Rolling Zinc Future

LME 3 Month Rolling Aluminum Future

The US Dollar Index was up almost 1% to 93.8.  The Mexican peso, British pound and Turkish lira fell.

US Dollar Index

Turkish Lira

British Pound

Mexican Peso

The November WTI crude oil future fell 4.6% to $49.29/bbl. Crude oil inventory was down 1.3% and the aggregate inventory level fell almost 1%.  The US rig count fell 4 rigs.  Crude oil production inched higher.  OCTG prices fell.  Natural gas prices fell almost 5% and natural gas inventory gained 1.2%. 


November WTI Crude Oil Futures and November Crude 15 Delta Put Volatility

Aggregate Energy Inventory (Blue) 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 (1983 – Present)

The US ten year Treasury yield continued higher closing the week up three basis points to 2.36%.  Rates were quiet except in Spain due to the turmoil surrounding the Catalonian independence movement.

U.S. 10 Year Bond Yield

German 10 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:

–        China strict steel capacity cuts/China getting serious about curtailing steel production

–        Low inventory levels/domestic or global restocking

–        Post hurricane development and production

–        China pumping up its “old economy”

–        Energy industry rebound

–        Graphite Electrode Shortage

–        Sharp drop in steel imports

–        Unexpected inflation

–        Weaker dollar

–        Flatbed trucking availability/transportation supply constraints

–        Section 232 Investigation

–        President Trump’s agenda

–        Infrastructure bill/long-term solution to highway spending bill

–        Unplanned domestic supply side disruptions

Downside Risks:

–        Crashing iron ore, scrap and finished steel prices

–        Political & geopolitical uncertainty

–        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