Time to break out the bubbly?
Mr. Bull: Recent events must have reinforced your doomsday scenario, Mr. Gloom. First we had (and still have) turmoil in the Middle East, which caused crude oil prices to skyrocket yet again and slowly approach 2008 levels. The massive earthquake/tsunami in Japan has put the world’s third largest economy on ice for the time being. So all is bad again, is it not? Not so— the global economy has been growing quite robustly and there are no signs that even these two events will be able to derail it. Same goes for the steel business. The global capacity utilization rate is 82 percent, and even in the US it’s above 70 percent. Moreover, we now know that the US is growing at a much stronger rate than previously thought. Prices are on the rise and it’s not only because of increasing raw material costs. Car sales are strong and there are even signs that housing might be on the mend starting this year. Inflation is low, consumers are opening their purses and America’s manufacturing sector is staging an impressive comeback. Largely because of exports, it has regained almost two-thirds of the drop it suffered during the recent recession. It might be too early to pop the champagne, but some congratulations are in order and perhaps we can just sip sparkling wine instead.
Mr. Gloom: Although you might want to get drunk and forget about the realities of today, you need to stay sober and pay attention because this is exactly how 2008 played out. Oil prices went up only to collapse on their own weight, and the same thing happened with steel. Minor shortages and raw material increases created a short-lived hysteria which ended in disaster. The simple fact is, the more you inflate the price of commodities, the less people will consume them. And as soon as the upward momentum stops, it becomes a race to the bottom. I think some people call this a death spiral. I am afraid we are on the verge of a new one. Here’s why:
How many times did the flat rolled mills announce price increases since December, over a dozen? I can’t keep track anymore. The price of HRC doubled, and greedy mills started to produce more steel in the meantime. True, utilization rates are higher now, but this doesn’t give me a lot of comfort. I would much rather see mills restrain themselves and control output to control prices. Brand new mills are about to spit a lot of tonnage in the market; ThyssenKrupp is finally cranking up production, blast furnaces in Sparrows Point and a few other relics of industrial age have just changed hands, and the new owners will start operating them this summer. There soon will be glut of steel available. Recovery and demand is still fragile and this rally is about to run out of gas.
Mr. Bull: It’s hard to find any indications that the current rally is about to run out of gas. Sure, there will probably be a price correction and I might even agree with you that hot rolled coils and some specialty steel items got a bit out of control price-wise. But any correction will be nowhere near as precipitous as it was late 2008 because the most important economies in the world, the US included, are still in an expanding state. Scrap will stay more or less at present levels even though it might fluctuate every now and then, and Asian mills will be super busy with the reconstruction of Japan and this alone will make a lot of steel products tight in the mid- to long-term.
Even the US is chugging along very nicely, thank you very much. We recently found out that the economy has been growing stronger than we had thought, such as car manufacturers keeping busy and keeping demand for steel up. Better still, it’s not only the US economy. With the dollar exchange rate being as low as it is, exports from the US are strong. Finally, we are approaching a scenario where the world is not only looking at the US as a destination for their exports. US agricultural machinery is in high demand all over the world, especially in South America and in Asia. How busy are the Caterpillars and John Deeres of the world? Both companies have essentially reached the same employment level as before the crisis and are still adding to it. Essential items such as welding wire are, in fact, in short supply and mills from all over are scrambling to keep up with the rod supply to make this wire. Yes, I think I will have some of the bubbly stuff and toast to the current impressive recovery of the global and US economies. I think that this calls for a French label. Cheers!
Mr. Gloom: All the hype about possible supply disruptions from the Japanese disaster has died out very quickly. Typically, as soon as there is a disaster, the hype gauge bumps up a few notches; all this does is help speculators make money within a very short period of time. The fact is that reconstruction of Japan will take many, many months, possibly a year or two. In the meantime, there is still plenty of steel around. That’s why the softness started actually in China.
The US is chugging along? A few Americans may be buying new cars but the biggest steel consuming sector—construction—is still in the hole. Housing starts data for February were extremely disappointing. With the exception of August 2009, single and multi-family starts were the lowest of any month since records began in 1960. Single family totaled 375,000 units and multi-family 96,000. These figures were over 1.8 million and 400,000 respectively in 2006. The same horrid picture prevails for non-residential construction. Total square footage was 691 million in the last 12 months, down from a high of 1.9 billion in the 12 months through February 2007.
You can sell all the cars you like, and Cat can produce all the earth moving equipment it likes, but these won’t save the economy and steel markets. There cannot be a sustainable recovery without the construction sector—it’s as simple as that.
Mr. Bull: You really can’t compare the current construction malaise to the record numbers of 2007, nor can you compare residential housing to 2005 when that market peaked. Housing and construction are still down but there are months when there are signs of a fledgling comeback. Right now the spotlight is on a recovering manufacturing sector in the US which had been pronounced dead not too long ago by naysayers such as you. According to the Institute of Supply and Management (ISM) the manufacturing sector has been growing for 20 months. There is a reason that some high volume steel items such as hot rolled coils had such volatile price increases. Sure, a lot had to do with the rising scrap prices; but they also went up because US mills have a strong demand for it. So price increases were passed on and, except for a few market fluctuations, were absorbed by the market. Demand is strong because US manufacturers sell their wares in both the domestic and global markets. Consumer confidence in the US is high, consumer spending is up, March showed the creation of 216,000 jobs, and the country is far from a liquidity crisis. Yes, it is a slow process; but it is one that is gaining speed.
Mr. Gloom: It’s a very slow and fragile process—on that we can agree. But many things can throw this recovery off. By the time we talk again, a few more European countries could be bailed out, or a few more Arabic countries could be in civil war. The world is a boiling pot and there is no stability anywhere—not even the US.
As per steel markets and prices, there is no strong backing from raw materials this time. In fact, scrap and iron ore prices started to soften some. We are at a breaking point again. There is nothing holding steel prices firm so they will soften once again. You can wish it will be only a mild drop, but as recent history shows, there are no little drops. A $100/mt drop is the rule of thumb nowadays. Unfortunately, most of us will never learn when to stop and reduce inventory. After what seemed to be a strong rally, you probably loaded up your inventory as well. How ill advised… Year after year we have seen this scenario. Undisciplined, greedy and short-sighted steel businesses over-extend themselves and get punished in the process. I would much rather buy only what I need and pay a little extra. It’s not time for bargain hunting with big purchases. Like the old saying goes in Texas: “Fool me once, shame on you. Fool me—you can’t get fooled again.”
Mr. Bull: Yes, there are people like you who would prefer to buy the absolute minimum only. These are the people that get caught when their business picks up and they don’t have the inventory to react quickly to surging demand. Then they scramble and pay just about any price, thus contributing to the upward spiral. I have made the point many times—we operate in a global economy and we are exposed to market changes everywhere, particularly in Asia. Do you know that China has produced more steel in January and February alone than all three NAFTA countries combined will produce this year? The point is, even the steel companies in Texas will have to pay attention to the global picture or else they will get fooled again and again. The global economy is strong, demand for steel is up, and prices will go up. Ignore this at your peril.
Mr. Gloom: Well, at least I will not have to take the massive write downs when steel prices begin to plunge. You must have been outside for too long, waiting for the train we were talking about some time ago. Your judgment has become very cloudy. The US cannot move under the weight of its debt, the Middle East is in turmoil and Japan, unfortunately, is pretty much out of the global economy for the time being. Where will the European and Middle Eastern steel mills sell their goods which they might have otherwise sold in the Middle Eastern market? In the US or in Asia? It is getting very crowded there. Or are you dreaming of strong demand in Europe with the decrepit fringe of the Eurozone? This scenario, along with high energy prices, rising interest rates and other micro-economic factors will combine to depress steel prices in the short to mid-term, at the very least. Enjoy your high-priced bubbly stuff while you can, Mr. Bull. It is about to turn sour.