Another round of strong headline economic data was released earlier this week showing continued strength in the U.S. economy.  The ISM Manufacturing PMI posted 59.8, the ISM Non-manufacturing PMI reached 61.6, the highest level since 1997, auto sales rebounded to a 17.4m S.A.A.R., construction spending continued to increase with the growth rate of nonresidential spending picking up in August and the unemployment rate fell to 3.7%, the lowest since the 1960s.  The Atlanta Fed’s GDPnow upgraded its 3rd quarter to 4.1%.

September US Auto Sales SAAR

US Nonresidential Construction Spending Seasonality Chart

Despite this strong economic data, the flat rolled steel market continues to be under pressure with anemic new order volumes in the spot market.  NAFTA was resolved, but there was no change to the steel tariffs for Canada or Mexico. In fact, during President Trump’s Monday news conference regarding the new USMCA, he reiterated tariffs will continue and that the goal of the tariffs remains to protect the US steel industry in the name of national security by using tariffs with the end goal of implementing quotas.

President Trump said the following during his October 1st press conference regarding the USMCA:

“So — and we need steel.  We need steel for defense.  What are we going to do?  Go and say, “Oh, we’ll get our steel from an — like another country?”  We can’t do that.  Excuse me.  We can’t do that.  So we need steel and we need it badly for defense.  So I’m very proud of what’s happened with the steel industry.”

“Just so you understand what was going to happen: They (China) were going to knock out every steel plant we had, and then they were going to double and triple the price and we couldn’t have done anything about it.  It’s a very dangerous thing.  And we’ve employed a lot of people.  And billions of dollars is now flowing into our treasury.”

It’s perplexing to see falling prices and lead times for spot flat rolled when there has been no resolution or change in 232 tariffs/supply constraints and continued robust economic strength. The explanation for much of the weakness is likely due to a buyer’s strike that has lasted at least eight weeks, but why are buyers striking? 

From a steel buyer’s perspective, the right strategy during this time has been to delay purchases as long as possible and buy as little as possible.  For buyers that have been doing this, they have been rewarded week after week with sequentially lower prices and shorter lead times.  However, there doesn’t seem to be the same weakness in demand in the manufacturing industry i.e. for finished products according to the latest manufacturing reports.  This strategy has rewarded buyers each week, but the number of tons not bought are accruing and increasing upside price risk across the industry.

This has become a very crowded trade!

Sizable RFQs in both the physical and futures market have started to trickle in over the past week.  A V-shaped recovery is likely to occur once a floor is reached.  It is likely to occur when some massive orders are placed with domestic mills pushing lead times out and then being followed by compounded demand from both the sum of the tons not bought during the “strike” and lead times being pushed out simultaneously.  I believe buyers who faced compressed margins earlier in the year are trying to make up for those “loses” and are playing a very risky hand.  This pent up demand s likely the catalyst that drives the next leg of this rally and defines the next group of significant winners and losers with those first movers on physical purchases and those buying HRC futures being the winners. 

Trying to figure when it happens is a fool’s errand, but it is clear that unless the economy and manufacturing industry is heading in to a recession, the strength in demand will eventually overwhelm the weak hand of the “buyer’s strike.”  Every day that goes by, (buy side) anxiety builds as buyers accruing a growing number of tons to be purchased thus increasing their upside price risk exposure.  Also, every day that goes by draws January 1st 2019 closer.

The purpose of this report is to examine both upside and downside risks.  The upside risks look to outweigh the downside risks at the moment, but there have been some concerning developments to pay attention to.  The sharp increase in steel prices has undoubtedly led to demand destruction while employment issues are hampering productivity at some manufacturing plants.  Higher oil prices and interest rates as well as a stronger dollar are all headwinds for the economy.  Globally, both of China’s manufacturing PMIs both in September as their economy is clearly struggling with the trade war.  Turkey’s PMI fell to 42.7, which is a recessionary level.  Emerging markets continue to be under pressure as higher interest rates and a stronger dollar present major risks to these countries that took on dollar denominated debt.  China’s HRC price has been under pressure for the last two weeks breaking below the floor of its multi-month price range.      

The September ISM Manufacturing PMI dropped 1.5 points to 59.8, while the Platts TSI Daily Midwest HRC Index added $0.75 to $848.75.

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

The ISM Manufacturing PMI six-month moving average rose slightly to 59.27.

ISM Manufacturing PMI Six Month Moving Average (white) & Platts TSI Midwest HRC Index

The September ISM Manufacturing PMI continues to remain in very strong territory, but saw large drops in the new orders, supplier deliveries, inventories, prices and backlog subindexes. 

September ISM Manufacturing PMI

ISM Manufacturing PMI Seasonal Chart

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

This chart adds the new orders and backlog subindexes.

ISM Manufacturing PMI New Orders Plus Backlog

The chart below shows the producer and customer inventory subindexes rebounding with the customer inventory subindex mired in contraction. 

ISM Manufacturing PMI Inventory (white) & Customers’ Inventory (orange)

The ISM prices subindex fell below 70 to 66.9 for the first time all year.

ISM Manufacturing PMI Prices (white) & Platts TSI Daily Midwest HRC Index (orange)

The ISM PMI and subindexes remain at healthy levels, but are down in key areas on a YoY basis. 

The table below shows the monthly ISM and regional PMIs back to September 2017.

September US light vehicle sales surprised to the upside at a 17.4m seasonally adjusted annualized rate.

September US Auto Sales SAAR

The labor market continues to strengthen and auto sales responded in kind in September.

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

September monthly NSA auto sales totaled 1.43m units.

US Monthly Auto Sales

The seasonality chart below shows September sales in line with sales in 2015 and 2016, but below the highs made in 2017.

US Monthly NSA Auto Sales Seasonality Chart

This chart shows a three-month moving average of monthly US auto sales.

US Monthly Auto Sales Three Month Moving Average

The seasonality chart for the three-month average shows a steady 1.4 – 1.5 million unit range for September with 2018 at the low end of that range. 

US 3-Month Moving Average NSA Auto Sales Seasonality Chart

Seasonally adjusted August U.S. construction spending rose 0.1% MoM and 6.5% YoY.  Construction spending continues to grow at a slow and steady pace.

August US Construction Spending

Unadjusted August total construction spending was 6% higher YoY while YTD spending gained 5.3% YoY.

Unadjusted August total private construction spending was 3.7% higher YoY while YTD spending gained 4.8% YoY.

Unadjusted August private residential construction spending was 3.3% higher YoY while YTD spending gained 6.5% YoY.

Unadjusted August private nonresidential construction spending was 4.2% higher YoY while YTD spending gained 2.7% YoY.

These next two chart show monthly US construction spending back to 2014. August spending (red) continues to gain YoY and is the highest of the past 5 years for both residential and nonresidential.  August nonresidential spending rose at a faster rate than at any other point in 2018.

US Nonresidential Construction Spending

US Residential Construction Spending

Globally, September purchasing manager indexes were mostly lower with 15 countries declining to seven gaining.  The JP Morgan Global PMI dropped 0.3 points to 52.2.  The Turkish PMI dropped to 42.7, which indicates recession.  However, Russia and South Korea saw their PMIs rise back above 50.  At the top of the list are the United States and the Netherlands both at 59.8.  Australia’s PMI continues to gain rising 2.3 points to 59, likely benefiting from a weak Australian dollar.

The downtrend in European PMIs continued in September, except in the U.K.

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.

Eurozone (white) and Platts TSI North European HRC Index (orange)

The PMIs of the U.S., Germany and China fell MoM.

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

China’s official and Caixan PMIs moved lower.

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

China’s official PMI continues to trend lower and is the middle of the range of the past five years.

China Official Manufacturing PMIs (SEAG)

The table below breaks down China’s official manufacturing PMI subindexes. 

Chinese December HRC futures fell sharply in September.

China New Orders (white) & Chinese December HRC futures (red)

The two inventory subindexes continue to be in contraction.

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

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 

          Global economic strength

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

–          Chinese economic stimulus measures

Downside Risks:

–          Trade War Fallout

–          Turkey/emerging market contagion

–          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 

Last week, the October CME HRC future fell $8 to $831, while the Platts TSI Daily Midwest HRC Index rose $0.75 to $849.25/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 continue to see little movement.

October ferrous futures are listed below.

Flat rolled indexes were mostly lower.

The AISI Capacity Utilization Rate rose to 79.5%.

AISI Steel Capacity Utilization Rate and TSI Daily HRC Price

Last week’s September’s flat rolled import license data is forecasting a slightly lower MoM increase to 1.01m st.

Last week’s September’s tube import license data is forecasting a MoM drop of 54k tons to 473k.

September combined flat rolled and tube import licenses are forecasting an increase to 1.48m from 1.38m in August.

Flat Rolled (blue) and Tube (red) Imports

September AZ/AL import licenses are projecting a 17k ton MoM increase to 80k tons, with the forecast falling sharply WoW.

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.

Price changes of raw materials are below.

Last week, the October SGX iron ore future lost $0.44 or 0.6% to $68.18, while LME Turkish scrap gained $2.50 or 0.8% to $317/t.

The SGX iron ore futures curve has rallied over the last month with slightly more gains seen in the front of the curve than the back.

The chart below shows the 2nd month SGX iron ore future forming into a “triangle” pattern, which predicts a significant correction to result in whichever direction it breaks out.  In July, the price fell below the up trendline, but there hasn’t been any follow through on the down side. The future’s price then rebounded back into the triangle and has been drifting sideways since.  Ore volatility continues to be at ultra-low levels as ore prices have remained in a compressed range since March. 

2nd Month SGX Ore Future

Ex-flat rolled prices were mostly lower with the January Chinese rebar future falling almost 5%.

Last week’s economic data included disappointing data in the July Case-Shiller 20-City Home Price Index at 5.92%, August new home sales and August pending home sales. 

The S&P fell 0.5% WoW after trading to new all-time highs on Friday, September 21st.  Other global equity markets were mixed.

S&P 500

Steel mill stocks saw mixed results.

US Steel

Service center’s stocks were mixed.

Worthington Industries

Iron ore miners were mixed.

LME base metal’s prices were mixed with an almost 5% gain in zinc, but downward pressure in aluminum, copper and nickel, which was down almost 5%.

LME 3-Month Rolling Zinc Future

LME 3-Month Rolling Nickel Future

The U.S. dollar charged back above 95 to close the week at 95.13. Around 1% drops in the euro and Japanese yen offset this gain.  The Turkish lira continued to rebound closing the week just above 6.. 

US Dollar Index


Japanese Yen

Turkish Lira

The November WTI crude oil future gained $2.47 or 3.5% to $73.25/bbl.  Crude oil inventory added 0.5% and gasoline inventory added 0.65%, while distillate inventory fell 1.6%.  The aggregate inventory level rose 0.15%.  Crude oil production inched to a new high of 11.1m bbl/day.  The US rig count added 1 rigs and the North American rig count lost 18 rigs. The November natural gas future rose three cents or 1.1% to $3.01/mbtu. Natural gas inventory rose 1.7% to 2.77 trillion cubic feet.

October WTI Crude Oil Future (orange) and Nov. Crude 15 Delta Put Volatility (white)

Aggregate Energy Inventory (white) vs. 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 was unchanged closing the week at 3.06%.  Italian ten-year bond yields jumped 11% to 3.15%.   

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 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

–          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

–          232 exclusions

–          NAFTA Resolution

–          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