The march higher in HRC prices continued last week as tightness in the spot market persists and prices trend towards $1,200/st. Mills are looking to push their offers and spot transactions even higher, and they are waiting for those higher prices before they open their forward order books. This week’s report analyzes several of the key economic data releases from last week, the key take away being that the steel demand recovery and strength are intact. The largest problem that manufactures are facing is they have too little inventory for their immense and growing order books. Several of the dynamics that have previously been identified as “cracks” in the bull case for HRC prices have recently dissipated including iron ore, scrap and Chinese HRC prices. This, along with the unwavering demand outlook, leaves a clear path higher in the short-term for domestic steel prices. Because of the lack of activity in the spot market, we will once again take a look at the forward curve this week, where volatility and opportunities are widespread.

Two weeks ago we discussed how speculators were pushing the forward curve lower as they bet on an eminent price decline. The below chart shows how the HRC curve has reacted since then, with today’s curve in green, and the January 29^th curve in orange. The bottom panel shows the dollar per short ton difference in prices between the two.

With the front of the curve up approximately $100/st during the period, it appears the speculative short positions “lost” that bet. However, even with the move up in the curve, the shape continues to show lower prices starting in the second quarter. It is important to understand that this doesn’t necessarily mean the market’s expectation is for lower prices. This shape is a reflection of spot market supply and demand, where there is a premium for having material in hand today during a supply deficit. That premium does not apply for material in the future because there is uncertainty as to the future supply and demand dynamics. However, as time passes without changes in market dynamics, the curve should adjust higher in near term expirations to reflect the similar expected tightness in those months.

This presents an opportunity for physical market participants who have risks directly tied to steel prices and availability. For example, there are spot buyers who are unable to procure the necessary material for their business right now. If enough supply enters the market over the next few months allowing buyers to fully supply their business needs, spot prices would likely adjust lower. However, if the current tightness lasts, prices will likely move even higher, harming those businesses without enough steel. Buying the curve as a hedge will allow those businesses to profit in their worst case scenario of being undersupplied. If the market does turn lower with more available supply, the business will fill its supply needs, and the hedge does not necessarily lose. Because of the steep backwardation (downward slope) in the curve, the hedge is purchased at a discount to the current spot price, which may even end up below the spot price when the hedged month arrives, resulting in a “win – win” for buyers and their businesses.