Two weeks ago, mills increased prices by $40, and in normal times, we would know by now what spot prices the market would accept. However, now there is arguably more uncertainty as to price outlook. Mills have maintained their offers at $600 and have no reason to negotiate lower yet as they maintain strong order books for the next few months. However, buyers are sticking to their strategy of only buying material on their contracts at discounted levels to the spot index. With the mounting uncertainty around the coronavirus and its effects on the economy, there is no reason for buyers to take a risk through purchasing or holding inventory. Over the last week, some risks to the economy have exhibited themselves in asset prices and economic data, causing many to predict an economic downturn or recession. This week we will dive into some of them.

Oil prices were down almost 8% last week after OPEC and Russia failed to agree to a supply cut, and fell even more at the beginning of this week as Saudi Arabia increased production and cut prices. The price of crude oil can be viewed as a barometer of global demand, and the price plummeting is concerning. From the perspective of the steel market, energy is a significant component of the domestic steel demand. Many energy companies will struggle to generate enough cash flow to meet debt obligations with oil prices at current levels, which will create holes in mills order books as these companies pull back production or leave the market completely. The chart below shows the weekly correlation between oil prices and the 3^rd month HRC future price going back 7 years.

Oil prices collapsed in 2015 ahead of a manufacturing slowdown. Interestingly during this time, the correlation between oil and HRC futures increased, meaning that steel futures also declined. In periods where oil prices are declining, this correlation increases. Looking at the current spot market for both HRC and oil, this points to downside in the steel market.

Often during times of significant market volatility, asset prices diverge from underlying fundamentals. This creates opportunities for traders or hedgers, but confusion for others trying to develop long-term projections for their business. Last week, several economic data reports were released, and while backward looking, can give some insight into areas of strength or weakness in the economy. An area of strength was the construction spending report, which showed seasonably strong construction spending. While residential spending was a large driver of this strength, there were also positive revisions and growth in the steel intensive private, non-residential construction spending data. However, we also received domestic and global PMI reports, which showed lackluster sentiment in the manufacturing sector. This index tends to be a good gauge of demand in the steel sector, and is correlated to HRC prices at times. Further weakness in PMI readings should direct caution among buyers.

For buyers not ready to pay the elevated spot prices, and are worried about the economic outlook, we recommend planning and determining a price that you would feel comfortable buying. In a high volatility environment, the forward curve may give you that opportunity sooner than you think.