Getting close to the edge of the woods
I hope you didn’t choke on the champagne you wanted to break out the last time we spoke, in order to celebrate our “resurgent” economy in general and the steel market in particular. Yes, we had an uptick of sorts but it’s all gone now. You must have just caught a bad case of spring fever. Let’s start with the facts. The US economy has turned out to be less vivacious than anticipated. I know you don’t want to hear about the problems in the construction sector—both private housing and commercial construction—which will not recover in any meaningful way until 2013. A CEO of a major US mill has finally acknowledged this sad fact. Along with the temperature of your spring fever, steel prices—especially hot rolled coils—moved up quite smartly for a while, but the party is over. Demand, or a lack thereof, finally caught up with reality and HRC prices have crashed down to earth, dropping about $160/mt in the process. A lot of the earlier, pent-up demand happened because of “restocking” inventory. Guess what? Latest surveys of steel consumers show a high inventory level. There will be no restocking anytime soon, never mind whatever macroeconomic gibberish you will be quoting.
There are some segments of construction, such as manufacturing plants and apartments, that are doing very well. But I will have to agree with you; the housing market is still a drag on the whole economy. However, whatever the weak state of construction is taking away from the steel sector is made up with strong manufacturing. Fueled by the weak US dollar and high car demand, manufacturing is marching on. Also, look at other commodities—even though they cooled off some recently, there is demand for all kinds of commodities and their prices are high. And like it or not, steel is also a commodity, and along with others will remain strong.
Our major problem in the US is unemployment, but this is a normal adjustment period. Our wages went up too much too fast during the boom years. Those excess days are now over, yet Americans are still struggling to find those big paychecks. On the other hand, wages in developing nations are going up, which could result in more job creation in the US eventually. Plus, the dollar is weak and employment taxes and regulations are relatively favorable for businesses in the US. That’s why we always manage to shake off any recession or even depression thrown at us and still lead the world with our economy.
Trust our fundamentals and expect the same thing happening again. Yes, we are not quite out of the woods yet, but we are not too far. Once we get there, we will be the envy of the whole world again.
Wow, your unfettered exuberance of days past has certainly mellowed a bit. I even agree with you that steel has become for most part a commodity. And what are the commodities doing? They are getting soft. Would it not be a logical development that steel will go down as well?
Let’s face it—the steel business has been driven for too long by the pricing of raw materials. As far as the US is concerned, this refers principally to scrap. Scrap prices have driven up some steel prices to a level that is detached from reality. I strongly believe that this summer could see a major correction. As we have seen, the US did slow down during the spring and should the dreaded “summer hole” materialize, we could see a sharp drop in steel demand and, consequently, for scrap as well. As I said before, hot rolled coils have already started to fall from their lofty price perch (prices had gone as high as $950/mt ex-mill), even though some US mills are desperately trying to stop the precipitous fall. In the end, it will all come down to economics and we are not doing well here. The unemployment rate is a very good indicator and it does not bode well. The U-6 number, covering the underemployed, still hovers around 16 percent. The automotive sector has been doing relatively well, but who will continue to buy cars if consumer confidence does not appreciably recover? Ford and, to an extent, GM have fared well but Chrysler is still lagging behind. And I haven’t even started on the inflation factor that has arisen in many developed countries. My head is beginning to hurt…
Mr. Bull: You mentioned excellent car demand and even the Detroit “Big Three” making decent money. How is that possible if the consumer confidence is too low? I think people are sick and tired of saving and worrying about their jobs. Yes, some lost their jobs. But the American economy loses and creates 250,000 jobs a month. That’s why we are the most dynamic workforce in the world. We know how to adapt to changes. I think people finally realized that the worst is over and we are clearly in the recovery. I can’t say things are all rosy for everyone but it’s sure looking a lot better than in 2008 and 2009. Same thing applies to steel. We saw 40 percent capacity rates in 2008 and 2009; rates improved to 60 percent in 2010, and we are still filling our capacity more and more. With what, you might ask? With orders.
You mentioned the flat rolled steel prices going down. Of course they went down. It was bound to happen. The difference between US and international prices was $200/mt—that could not be sustained. Now our prices have corrected and the froth has been removed. In fact, we have already seen price increase announcements. Also, guess what? Americans are exporting again.
You say the correction will happen in the summer. I’d say the correction happened already. Prices clearly bottomed out in scrap, longs and flats. The next thing you know we will start seeing more price increase announcements. Inventory dynamics have changed in this country. No one wants to own stock because of volatile steel prices but low inventories are the main culprit for volatility. There is no inventory in the market to cushion the price movements. Therefore, you have seen these sharp price decreases, and now it’s time for another price increase.
Mr. Gloom: How right you are about the wild swings in the American job market. Problem is, however, that lately the losses clearly outpace the job gains. This so-called recovery is a jobless one if I have ever seen one. The car manufacturers, Chrysler excluded, made some money because the consumer is being squeezed by high energy prices and has to replace his car with newer and more efficient models. I grant you that Ford, GM and the mostly Japanese transplants have done a good job coming up with models that consumers want to buy. But how long can it last when the job market is weak and workers are justly concerned about their income situation? It seems to be a rule in the economic “esoterica” that the seasonally adjusted weekly jobless claims have to fall below 400,000 before more jobs are being added than are being lost. As we move into summer, the number remains decidedly above that threshold (close to 430,000). And there is one more unfortunate circumstance: the US manufacturing sector, touted all year long as the sector that will pull the US out of recession, has to cope with a massive disruption in the supply chain because of the earthquake in Japan in March. This problem will get worse before it gets better. The car industry will be particularly affected, because even the original US car manufacturers depend on vital Japanese parts. So the huge downward pressure on steel prices was not just because the US market had gotten too far ahead of the world. Demand has stalled—that is the principal cause for the weaker steel prices. Temperatures may soar during the summer as they always do, but it could be a very frigid climate for the US economy in general and the US steel industry in particular.
Mr. Bull: Now I want to cry, then shoot myself—reading your rhetoric makes me depressed. The earthquake in Japan is causing steel demand in the US to go down? Our jobless numbers are skyrocketing? The US economy is going into a frigid climate this summer? These are all false assessments that you want to believe and use to make yourself miserable. What else have you got? You are forgetting the turmoil in North Africa and Middle East. Somehow, the world is not coming to an end and mills keep on churning tons and prices are still at the level that you would only dream of in the pre-2004 era.
Surely we are on a down cycle. But the cycles are so short right now; before you know it, the prices are moving in the other direction. The world population is growing and it is demanding higher wages and higher standards of living. In places like China, Brazil and India, millions of people are crossing the poverty line every day. The world needs every bit of steel production it can get. That’s why we are already seeing pre-crisis levels of steel production around the world. And yes, here in North America we are not there yet. We are still struggling with our overbuilt housing and non-residential market. But everything else is looking beautiful. Automotive, durable goods, manufacturing, GDP all point to strong days for steel just ahead. We will have corrections from time to time, but no graph can be a straight line up. Overall, however, the direction of the chart is clearly moving up. Just wait another few weeks and you will see.
Mr. Gloom: Your sobbing must have distorted your perception. The earthquake in Japan caused a disruption in the supply chain for the manufacturing sector. This is a fact and fits in nicely with your previous pronouncements that we are all a global economy now. Cars are affected as well and eventually this will be a contributing factor to less-than-stellar demand for steel. Pointing out the global population growth is nothing short of disingenuous. The growth is taking place in countries or areas where the spending power per year can be expressed in three-digit amounts at best. Fact is, the revisions for Q1 and initial indication for Q2 are not good. Consumer spending and economic growth in the US have both been revised downward. This cannot come as too much of a surprise to anybody. A lot of household spending has to be diverted to paying for gasoline and the unmitigated unemployment level will not allow for any confidence to take root. Add to this the continuing debt crisis in the developed world where, at least for now, most of the consumer spending is taking place. If the US will ever get serious about debt reduction, drastic budget cuts and higher taxes will be needed. Not the best prospects for getting the economy on sound footing again. At least you agree with me that we are in a down cycle. Steel mills all over the world will feel the pinch eventually and it will start in the summer of 2011.