It turns out the sky is in fact not falling.  However, flat rolled lead times and prices are.  This is somewhat surprising as there has been no change on the tariff front, flat rolled imports fell in August and economic data indicating the economic strength continues to build momentum rolls in. 

The AISI Capacity Utilization Rate finally rose above 80% at 80.2%.  The August ISM manufacturing PMI is at the highest level since 1984 and the ISM Non-Manufacturing PMI remains at a very healthy 58.5.

The unemployment rate is at 3.9%.  Second quarter annualized GDP stands at 4.2% and the Atlanta Fed’s GDPNow is forecasting 3.8% growth in Q3.  The NFIB Small Business Optimism Index rose to 108.8, the highest level ever.  The S&P 500 closed at its all-time high on August 29th

The data and the steel market have diverged.  Here is one theory of what is happening and how a V-shaped recovery could play out for the rest of 2018.

In July, data shows service centers look to have added a sizable amount of inventory some of which was from almost one million tons of flat rolled imports and some of which was likely due to a catch up in deliveries from domestic mills.  This resulted in service centers refraining to some extent from placing new orders in the spot market.

According to the July Durable Goods Report, shipments fell 10% and new orders dropped 16.5% MoM.   Months-On-Hand equals inventory divided by shipments.  Assuming inventory is unchanged, a sharp drop in shipments leads to a sizable increase in months-on-hand.  Domestic mill lead times were also falling throughout July as service centers pulled back, which further affected the inventory calculation for OEMs.  Sentiment declined and “buyers strike” has been the buzzword of the industry in August.

These two seasonality charts show unadjusted shipments and new orders to compare the past three years.  In 2016 and 2017, shipments and new orders dropped sharply in July only to rebound sharply in August.

US Durable Goods New Orders Total Not Seasonally Adjusted

If the sharp gains in shipments and new orders seen in August of 2016 and 2017 occurred in August 2018, then OEMs will have realized their inventory levels that looked healthier at the end of July were once again looking light at the end of August. Here is the key….not only had the lead times receded significantly during July and August making it easy to hold lean inventory, but also buyers holding back purchases were rewarded week after week for delaying purchases as offers for spot tons kept getting cheaper.   The supply chain strategy of underweighting inventory that worked so well in 2016 and 2017 was back on top.  However, similar to January 2018, we see upside risk mounting.    

US Durable Goods Shipments Total Not Seasonally Adjusted

Watch for the August MSCI flat rolled daily shipment rate to remain strong and service center inventory to fall dramatically, especially considering August flat rolled imports look to have fallen back to 850k for the month.  This will provide yet another data point confirming demand side strength.

OEMs have been delaying purchases due to the dynamics described above, which translates into pent up demand.  Spot prices have fallen sharply in recent weeks.  We expect the floor will soon be realized most likely after some large orders are placed. Those orders will push out lead times abruptly and then look out.  Buyers will be, at best, on short notice that quotes will be pulled and then prices and lead times will jump.  Suddenly those inventory levels will become problematic once again.

Other events to watch for include the ongoing labor negotiations with USW, US Steel and ArcelorMittal and Hurricane Florence.

The following issues are the foundation of our current bullish view:

              Steel tariffs and quotas

              Domestic economic and manufacturing strength

              A rebounding and strengthening US energy industry

              Persistently low OEM inventory levels evidenced in the ISM, MSCI and Durable Goods reports

              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 September contract negotiations

–          Chinese economic stimulus measures

Downside Risks:

–          Trade War Fallout

–          Turkey/emerging market contagion

–          232 exclusions

–          NAFTA Resolution

–          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 September CME HRC future added $4 to $865/st, while the Platts TSI Daily Midwest HRC Index fell $11 to $870.5/st.  

September CME HRC Futures (orange) vs. Platts TSI Daily Midwest HRC Index (white)

The CME Midwest HRC futures curve is shown below with Friday’s settlements in orange.  2019 HRC future’s prices moved down a good clip and are at levels seen just before President Trump revoked tariff exclusions on Canada, Mexico and Europe.   

October ferrous futures are listed below. Australian coking coal was up almost 8% WoW.

Flat rolled indexes were lower with domestic prices leading the sell-off.

The AISI Capacity Utilization rate rebounded to 79.8%.

AISI Steel Capacity Utilization Rate and TSI Daily HRC Price

August’s flat rolled imports are forecast to fall almost 200k tons MoM to 803k. 

August’s tube import forecast is to fall 63k tons to 508k.

August’s flat rolled plus tube import licenses are forecasting a large drop to 1.31m.

Flat Rolled (blue) and Tube (red) Imports

August’s AZ/AL licenses are forecast to fall 32k tons to 62k.

Galvalume Imports (blue) w/ 3 Mo. Moving Average (red)

Below are HRC, CRC and HDG prices and differentials using pricing from SBB Platts.  Differentials have been decreasing in recent weeks.

Tariff adjusted prices continue to indicate imports will remain be relatively depressed through year-end.  The following charts compare the normal differentials from above with the tariff-adjusted differentials.  For instance Midwest HRC – (1.25 x China Export) + (AD/CD duties) is the red line (except China’s 250% tariffs were not included in the math as they obviously prevent any imports, but the Chinese export price can still be used as a proxy for the rest of Asia).  The charts below compare the current tariff adjusted differentials (red line) to where it would be on their historical unadjusted charts (blue line).  

Turkish HRC had been a buy starting in June, but then Trump increased the tariff on Turkish steel to 50%.  The charts below show the historical differential between Midwest HRC and Turkish import HRC prices in blue and the Turkish import price adjusted for the 50% tariff in red.  The increased tariff will provide a boost to domestic demand likely prohibiting Turkish tons for the rest of 2018.

Chinese/Southeast Asian HRC price differentials have moved back to the middle of the range.  Brazilian and Russian steel remains unattractive.

How flat rolled imports playout for the rest of 2018 will be interesting to see.  Following the increase in Turkish tariffs, the risk of additional tariffs or other defensive measures for any country could be taken by the Trump administration and D.O.C. must be considered more carefully and should result in decreased imported tons.  The window for 2018 delivery is practically closed. Imports are expected to fall into year-end.

The SBB Platts HRC, CRC and HDG pricing is below.

Busheling fell 5% playing catch-up for the month due to the lagged settlement price.  However, scrap has been clawing back its losses following the Turkish meltdown scare.  Australian coking coal and iron ore saw nice gains.

The September LME Turkish scrap future added $7.5 or 2.4% to $320/t while the September SGX iron ore future gained $2.82 or 4.3% to $68.32/t. 

The SGX iron ore futures curve has sold off and flattened slightly over the past month.

The chart below shows the 2nd month SGX iron ore had broken below its longterm up trend.  The “triangle” pattern predicts a significant correction to result, but the correction failed to materialize and instead rebounded back into the triangle moving higher along with the rally in finished Chinese steel futures.  Then that rally failed and we moved back below the uptrendline.  Ore volatility is ultra-low as prices remain compressed and range bound. 

2nd Month SGX Ore Future

Ex-flat rolled prices were quiet except Chinese rebar futures which gained 2.6%.

Most of the economic releases below were crunched in last week’s report and above. July factory orders ex-transportation gained 0.2% MoM.  July’s final durable goods orders ex-transportation were up 0.1% while new orders for capital goods nondefense ex-aircraft rose 1.6%, which gained vs. the preliminary MoM increase of 1.4%.

Stock markets slipped last week with the S&P 500 down almost 1%.

S&P 500

Steel mill stocks saw EAF producers rally and integrated mills fall.

AK Steel

Service center’s stocks were mostly lower with Ryerson the one bright spot up 1.4%.

Friedman Industries

Ore mining stocks were mixed.

LME base metals were lower with nickel falling 3.5% and aluminum down 2.6%.

LME 3-Month Rolling Nickel Future

LME 3-Month Rolling Aluminum Future

CME December Copper Future

LME 3-Month Rolling Zinc Future

Currencies were quiet with the US dollar gaining almost 0.25%.  The Turkish lira rebounded slightly while the Russian ruble was down 3.6%.

US Dollar Index

Turkish Lira

Russian Ruble

The October WTI crude oil future slipped $2.07 or 3% to $67.84/bbl.  Crude oil inventory fell 1.1%, while distillate and gasoline inventory levels increased, resulting in little net change for the aggregate inventory level.  Crude oil production was flat at 11m bbl/day.  The US rig count was unchanged while the North American rig count lost 24 rigs. The October natural gas future dropped $0.14 or 4.8% to $2.78/mbtu, while inventory rose 2.5% to 2.6 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 gained eight basis points to 2.94%.

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 September contract negotiations

–          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