The Midwest HRC price continues the rally that began at $365/st in December, 2015.  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 $2 to $624, while the September CME Midwest HRC future gained $3 to $638. Global and domestic fundamentals continue to strengthen.   Persistent low inventory levels held by OEMs and service centers have been discussed in this report all year.  However, this past ISM report indicated conditions are ripe for a massive restocking rally by end users similar to what was seen in 2011 when HRC prices rallied from $550/st to $875/st. 

That’s right. The potential for domestic HRC prices to rally hundreds of dollars in a short period now needs to be considered and discussed.  An explanation for why this potential is on the table is outlined below.     

September CME HRC Futures vs. TSI Daily Midwest HRC Price

At the end of each Week Over Week report is a list of upside and downside risks that influence the domestic HRC price.  That list will remain at the end of the report, but going forward the risks deemed to be most timely and significant will be listed below.

At its core, the purpose of this report is not to forecast HRC prices, but to present possibilities to be considered in FGM’s “If this, then what?” framework in order to evaluate business risk tied to steel prices and availability.

Upside Risks:

–        Rallying ferrous raw materials and global finished steel prices

–        Low inventory levels/domestic or global restocking

–        Post hurricane development and production

–        China pumping up its “old economy”

–        Energy industry rebound

–        Weaker dollar

–        Graphite Electrode Shortage

Downside Risks:

–        Political & geopolitical uncertainty

–        Domestic automotive industry under pressure

–        Rebound in import volumes

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

The August ISM Purchasing Managers’ Index surprised to the upside gaining 2.5 points to 58.8 and handily beating expectations of 56.5.  The PMI is up 9.4 points YoY showing strength in the usually slow month of August.

ISM Manufacturing PMI (white) and TSI Daily Midwest HRC Index (orange)

The ISM PMI sub-indexes are included below.  Inventory data was peculiar. The producer inventory sub-index gained 5.5 points while customers’ inventory fell sharply to an ultra-low 41.  Employment gained 4.7 points to 59.9, the strongest since June 2011.  Backlog of orders added 2.5 points to 57.5.

ISM Manufacturing PMI

New orders and backlogs remain at strong levels.

ISM Manufacturing PMI New Orders (white) and Backlog (orange)

As noted above, there was a large divergence between the producer and customer inventory sub-indexes.

ISM Manufacturing PMI Producer (white) and Customers’ Inventories (orange)

The chart below shows the difference between the two sub-indexes through time.  This month’s difference of 14.5 was explained by raw material inventory expansion on the producer side, the strongest since September of 2010 and increased end user demand depleting customers’ inventory. 

ISM Manufacturing PMI Producer Inventory Minus Customer Inventory

ISM Chairman Timothy Fiore said the following on this month’s conference call:

 “Given other strong numbers in the overall indexes, the expansion in the raw material area is considered a very positive move as it is likely due to stocking up effects  where industries are calling for more deliveries from suppliers.  The customer inventory sub-index saw major contraction likely due to end user demand expansion; the  strongest contraction we’ve seen since May 2011.  This was due to a 5 point drop in “too high” and an 11 point gain in “too low.” What that means to me is that the  ultimate customers have depleted their available inventory and are looking for more material to be delivered to them from (producers’) production facilities.”

A divergence of this magnitude seldom occurs.  If you look at 2010 and 2011, you see some similar behavior as has happened in the past couple years where both producers and customers contracted inventory for an extended period of time (contraction is indicated below the red line).

ISM Manufacturing PMI Producer (white) and Customers’ Inventories (orange)

2009 – 2012                                                             2014 – 2017

Then in 2010, producers stocked up on raw materials while customers kept their inventory lean.  The differential shot up to 17.5 and then stayed above or just below 10 until mid-2011.  During that time, the Midwest HRC price rallied from $400 to $700 and then from $550 to almost $900/st. 

ISM Prod. Inv. – Cust. Inv. Differential (white) vs. TSI Daily HRC Index (orange)

The fundamentals look to be repeating themselves again.   The restocking drumbeat is getting louder folks. 

Get prepared for a breakneck rally if this great restocking occurs.

Below is the ISM Manufacturing PMI by month with sub-indexes.  The indexes are very strong with the inventory index at the lowest level since 2011. 

The regional PMIs were led by a jump in the Empire Manufacturing Index.

The colors in the table above correspond to the appropriate PMI index below. The chart on the right normalizes the data.   The data shows a broad based uptrend.

August US auto sales annualized at a16.03m unit rate fell from the 16.69m unit rate in July and missed expectations of a 16.6m unit rate.

August US Auto Sales SAAR

The daily auto sales rate (DSR) for North American dealers was up 5% MoM and down 1.1% YoY as GM sold over 275k units.  European automaker’s DSR inched up 0.7% MoM, but was down 10.4% YoY.  Asian automaker’s DSR fell 9.5% MoM and 6.6% YoY.  Year-over-year year-to-date auto sales are down for all three segments and down 2.8% in aggregate. 

Auto sales have diverged from an improving unemployment rate. 

US Auto Sales (white) and the Inverted Unemployment Rate (orange)

Actual August sales of 1.475m units saw an increase of 67k units gaining 4.8% vs. July.  USA Today reported that up to one million cars were wrecked by Hurricane Harvey.  Replacing those cars will drive automotive sales higher in coming months.  A much needed boon for the automotive industry.

US Monthly Auto Sales

The three month auto sales average should get a boost as well.  Currently, it looks to be range bound in a healthy but not spectacular range.

US Monthly Auto Sales 3 Month Moving Average

General Motor’s big month decreased their inventory sixteen days to 87, which was still fourteen days above inventory held one year ago. Overall, automotive dealers are holding 70 days or 2.3 month-on-hand. 

Nissan is the only dealer of the top six that saw inventory levels move to a concerning level.

Wards Auto Inventory Data per Auto Manufacturers

Each of the top six automotive manufacturers are seeing inventory days on hand trending higher.

Wards Auto Inventory Days On Hand

GM’s sharp drop is a great sign as they’re 24% market share (of the big six) is the largest while Nissans bloated inventory has reached the highest level since 2014, but they only account for 10% of the big six’s market share.

Top Six Auto Manufacturers August Sales

July US construction spending slipped 0.6% MoM missing expectations of a 0.6% gain.  Construction spending gained 1.8% YoY.

July US Construction Put in Place

While spending was disappointing, the long-term uptrend remains intact.  YTD total construction spending is up 4.75% YoY.

YTD Total private spending is up 7.9%.

YTD private residential spending was up 11.9% YoY.

YTD nonresidential spending was up 3.57% YoY.

The Global PMI picture improved in August with the JP Morgan Global Manufacturing PMI gained 0.4 to 53.1. The US and Eurozone PMIs of 58.8 and 57.4 are strong.  21 of the 25 PMIs below improved MoM.  India and Indonesia pulled themselves back above 50.  Only South Korea saw their PMI in contraction.

The Eurozone, Germany, Italy and France all saw their manufacturing PMIs improve continuing their uptrends.  Spain fell for the third straight month.

Eurozone (white), German (blue), Italian (green), French (yellow) and Spanish (red) Manufacturing PMIs

Germany and the US continue to lead while China and Japan remain in decent shape.

US (white), German (blue), Chinese (green) and Japanese (red) Manufacturing PMIs

China’s Caixan PMI, which is focused on private manufacturing vs. SOEs, has rebounded sharply since the spring sell off.  This correlates with price rallies in iron ore, Chinese finished steel products and base metals.

China Official (white) and Caixan (orange) Manufacturing PMIs

There was little change in China’s Manufacturing PMI sub-indexes.   The one large move is in the input sub-index which gained 7.4 points to 65.3.

Examining and comparing the manufacturing PMI sub-indexes of the Chinese and US PMIs, they have a similar trend of low inventory and now this divergence between producer raw materials and end user inventory levels.

China Stocks of Finished Goods (white) & Inventories of Raw Materials (red)

Little change in these two sub-indexes. 

China New Orders (white) & Backlogs of Orders (red)

The August employment report showed a gain of 156k jobs, missing expectations of 180k while July’s data was revised 20k jobs lower.  Manufacturing payrolls surprised to the upside gaining 36k jobs in August and July’s data being revised 10k jobs higher to 26k.  The participation rate was flat at 62.9%.  The unemployment rate fell to 4.4%

Monthly US Nonfarm Payrolls SA

The table below compares the prices changes of a cross section of steel related raw materials and finished products.  Midwest HRC prices remain near the bottom of the list begging the question will we see a sharp rally in Midwest HRC prices?  Interestingly, the October CME HRC futures are $16 ahead of the TSI Daily Midwest HRC price of $624/st.

The increase in raw materials is pressuring the flat rolled cost curve higher. AK Steel announced a price increase on September 6th, which it communicated it would be doing in response to higher costs during its most recent earnings conference call.  Additionally, the lack of inventory and expected drop off in imported steel should further exacerbate the price rally over the next couple months.

We see the following issues as the foundation of our current view:

     -Rallying ferrous raw material prices, global finished steel prices and base metal prices

     -Conditions ripe for a restocking 

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

     -A global uptrend in manufacturing purchasing managers indexes

     -A rebounding US energy industry

     -Sharp drop in imports in the second half of 2017

As of Friday’s settlement, the September CME Midwest HRC future ended the week up $3 to $638/st.  Q4 gained $6 to $640 while the first half of 2018 was up $5 to $640.

Global flat rolled prices were a bit mixed.

The TSI ASEAN HRC continued to rally gaining $22/st to $513/st while the TSI North European HRC Index closed right at the March 27th high of $554/st, gaining $9 on the week.

Flat rolled imports are up slightly YoY, while tube tons have exploded with July up 140% YoY. 

Flat Rolled (blue) and Tube (red) Imports

August flat rolled imports are projected to move lower vs. July, however remain elevated.  We are expecting a sharp drop off in flat rolled imports as interest in import deals had been subdued on both sides due to the complications surrounding the uncertainty of the 232 Investigation through most of Q2. 

Tube imports have exploded this year and look to exceed 800k tons again in August.  We expect tube imports to reverse in the short term for the same reasons as flat rolled imports, however this year’s build warrants attention.

Below are HRC, CRC and HDG prices and differentials using pricing from SBB Platts.  There were big shifts lower in HRC and CRC differentials this week.  The lack of deals made in Q2 due to the Section 232 Investigation and now the closing of the price window affirms our belief that imports will decline precipitously in the near term and stay depressed until early 2018 at the earliest.

HRC prices were up across the board. Brazil, South Europe and India led.

CRC prices saw only gains as well.  Brazilian and East Asian prices were up the most.

Same with HDG  prices, especially Chinese and Brazilian prices.

AISI Steel Capacity Utilization Rate and TSI Daily HRC Price

AISI capacity utilization was flat at 75.6% and remains at a very healthy level.

It was another week of gains across the ferrous raw material space.  Scrap, pig iron and coal saw nice gains.  Iron ore was close to unchanged. 

Iron ore and TSI Turkish Scrap continue their bullish uptrend. 

The iron ore curve has shifted higher vs. early July and the curve continues to move towards a steeper backwardation.

October Chinese rebar futures gained 7% while OCTG fell 9%.

Most of the economic data below has already been covered above.  There was improvement in the second quarter GDP estimate moving it up to 3% from 2.6%.  The PCE Core Index at 1.4% YoY continues to show no signs of inflation.   July pending home sales fell 0.8% MoM, missing expectations. 

The S&P 500 gained 1.3%.  The Nikkei and China CSI 300 also gained 1%.   

S&P 500

Steel stocks all moved much higher.

AK Steel

Iron ore stocks were all up nicely.

It was another bullish week in base metals.  Nickel gained 4.8%, zinc gained 4%, aluminum gained 3% and copper gained 2 – 2.5%

LME 3 Month Rolling Zinc Future

LME 3 Month Rolling Aluminum Future

The US dollar was unchanged.  The Russian ruble gained 1.9%, the Chinese yuan gained 1.33% and the Mexican peso shed 1.5%.

US Dollar Index

Russian Ruble

Chinese Yuan

Mexican Peso

The September WTI crude oil future was down 1.2% to $47.29/bbl.  The US rig count lost 13 rigs. Production was unchanged.  Crude oil inventory fell 1.2% while the sum of crude, distillate and gasoline inventory was down 0.55%.  Natural gas gained 6.15% to $3.07/mbtu, while inventory gained almost 1%.  The average gas price jumped 9.6% to $2.59 due to disruptions caused by Hurricane Harvey.

Octber WTI Crude Oil Futures and October 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 U.S. 10 year Treasury yield was flat at 2.17%.  Rates were pretty quiet last week.

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:

–        Rallying ferrous raw materials and global finished steel prices

–        Low inventory levels/domestic or global restocking

–        Post hurricane development and production

–        China pumping up its “old economy”

–        Energy industry rebound

–        Weaker dollar

–        Graphite Electrode Shortage

–        Flatbed trucking availability

–        Section 232 Investigation

–        President Trump’s agenda

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

–        China getting serious about curtailing steel production

–        Transportation supply constraints

–        Post-election economic pick up

–        Unplanned domestic supply side disruptions

Downside Risks:

–        Political & geopolitical uncertainty

–        Domestic automotive industry under pressure

–        Rebound in import volumes

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

–        Sharp and persistent drop in oil and 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