While spot HRC prices continued to slide over the last week, there appears to be a change in the market’s sentiment regarding the pricing outlook. The futures curve saw buyers continue to enter the market, pushing the curve higher in 2020 for the second week in a row. Some of this buying is likely attributable to end users locking in tonnage at low prices for next year. However, this is creating an interesting divergence between spot prices and future curve prices, which provides insight into the market’s expectations. Below is a chart of the 6^th month future price minus the 3^rd month price, showing the divergence, or contango, of near term versus longer-term prices.

The contango is reaching historically high levels, and these peaks tend to precede spot price rallies. The steep futures curve reveals the market’s expectations that spot prices in the future will be higher than the current price. Therefore, the ideal strategy for steel purchasers is to buy spot tons now. This is a change from their successful approach over the last several months of delaying purchases into shrinking lead times.

Another indicator that is also reaching an inflection point is the China price differential, the difference between the Midwest HRC price and the China export price, including transportation costs.

Historical data tells us when the differential crosses the horizontal red zero line, a sharp rally occurs in the spot price. This week the differential breached the zero line. Whether you believe prices have reached a bottom or still have more room to fall, it is important to understand the current risk and reward for your business in terms of pricing. Based on the current conditions, we estimate a downside price reward for a steel purchaser of $20 to $40/st while the upside price risk is $130 to $150/st. Hedging future purchases and/or buying spot tons is the obvious decision right now.