During times of extreme volatility, panic and uncertainty, fundamentals are disregarded and assets trade based on sentiment, credit availability, and margin account stress. We have seen this as gold and bond prices moved lower at the same time as equities and commodities, which is an abnormality in standard financial market relationships. The domestic future curve was not spared, and dropped approximately $80/st over the last month.

However, the spot price has remained elevated because the fundamentals still matter in the spot market. While the actual transactions have been sparse, lead times are extended, order books are currently full, and there is limited spot availability. Mills continue to hold offers at or above $600 for HRC, despite the crumbling demand outlook and lack of new orders.  Additionally, with energy prices collapsing and automotive production shutdowns, mills will likely face cancelations, but seem oblivious to the holes this will create in their order books as they refuse to negotiate lower spot prices. This could be due to timing and the uncertain scrap outlook, as mills do not want to drop prices until they have a better grasp on where scrap will trade next month. As we look at future expectations for scrap and HRC prices, we will look to the changing fundamental outlook to help with forward curve price discovery.

The ferrous future curves are not only a display of future expectations, but they also display timing of the changing fundamental outlook. However, with the uncertainty surrounding the coronavirus duration and size of the impact on the steel market, the curves could trade in a wide range. Some historic relationships should guide the limits of these ranges. For example, due the spread between scrap and HRC, called the metal spread, is a relationship that trades in a range due to the correlation of the two commodity prices. The below chart shows the historical relationship, removing the 2018 peak in HRC prices in order to display the fundamental relationship.

Both the busheling and HRC forward curves are used to project the metal spread through June, where it reaches the red line at one standard deviation below average. While the spread trades in a wide range, it is mean reverting because of the supply and demand dynamics in the ferrous market. A low metal spread signals mill are less profitable and supply is reduced through production cuts. Based on the current scrap outlook, there is not much more room for the HRC future curve to fall.

Additionally, as the expectations for demand and future pricing decline, upside price risks are growing. It is possible that the coronavirus spread forces mills to shut down mills, just as it has for automotive plants. From a public policy perspective, the chances of an infrastructure bill have increased as the costs to borrow have declined. There will be political pressure to stimulate employment and growth if the economy moves into a recession. The risk/reward ratio, based on the current future curve, is skewed to the upside, and those with future physical steel needs should take advantage of these cheap prices.