The market acceleration continued last week with indexes moving into the mid $800/st range for HRC. This continued into this week as mills have started asking for $900+ for February availability. These are unprecedented price moves, and with the market still in a structural shortage, getting worse by the day, mills appear to have unlimited control increasing prices. We have heard many in the market describe the current rally with the following phrases, with which we would generally agree: “This cannot last forever”, “Beware of the other side”, and “This is unsustainable”. However, this same price rally has also been described as “euphoric”, “a mania”, and “a speculative bubble”. To these, we take exception, and this week we will dig into the dangers of accepting this narrative instead of understanding the fundamentals driving the price higher.

In both commodity and financial market history, there have been numerous occasions where prices have moved to unsustainable levels, driven by multiple factors, including psychology and emotions, which are being studied by behavioral economists. Rather than getting into the obscure details of behavioral science, let us look at a recent real world example of speculation: Negative oil prices. Pandemic related shutdowns, a Saudi led price war, and an oversupplied market drove domestic and global oil prices to the lowest levels since 2015 in the spring. However, these fundamental factors were not the cause of prices collapsing into negative territory on April 20^th. Rather, negative prices came about when speculators bought and held futures with no intention of purchasing the contractually obligated barrels of physical oil. They were only hoping to sell the futures at a higher price. The market discovered this and made the speculators pay a significant price to unload the contracts days before they were required to take delivery of physical oil. Once this speculative position was closed, the market price normalized and moved back above $20/barrel within days.

Let’s turn to the HRC futures market. Any entity taking positions in the exchange traded HRC futures contracts must be designated as either a speculative or commercial position, which are aggregated and reported. Speculative entities are broadly labeled banks or funds, while commercial entities are mills, service centers or end users all engaged in hedging physical material. The below chart shows the weekly changes in the aggregate speculative positions.

Speculators – those taking positions with the sole purpose of predicting where the price will go – are currently flat. They are not betting that the price will go either direction. Why does the distinction between fundamental market factors (in the report below) and speculative positioning matter? Because speculation and “bubbles” can end suddenly. However, major changes in supply and demand will take time. In a market that is experiencing a structural steel shortage, driven by increasing demand during the economic recovery and constrained supply, it will take multiple months for these dynamics to rectify. Last year’s prices are not anywhere in the near future.