Conversations with Mr. Bull and Mr. Gloom..Rising markets

Friday, 26 May 2006 14:26:35 (GMT+3)   |  
       

Mr. Bull: Steel prices in the US are surging on all fronts. Some experts proclaim this to be 2004 all over again. Even former laggards such as wire rod seem to be catching up. Moreover, the US economy seems to be in robust shape, and demand is expected to stay strong throughout the remainder of the year. Steel mills continue to make good profits, and scrap seems to be steady. We don't see the tremendous surges of 2004, but 2006 is shaping up to be a very good year. Mr. Gloom: I am not blind -- I see the incredible bull ride coming to a peak. This certainly looks like 2004 except for the fact that people are now used to these wild market conditions, so no one seems to be very concerned. The problem is, China has been slowly waking up, and when it wakes up, it's hungry. There is simply not enough excess steel capacity in the world to take care of the coming up ticks in demand. A one percent increase in demand causes a 20 percent increase in prices. But one think remains constant my friend: What goes up must come down! Mr Bull: There could very well be a downward correction in prices. But it will not come before Q1 2007. And if it does happen, it will be a very mild correction. A big reason for higher steel prices is the development of the world's largest steel market - China. With another imminent rollback of the Value-Added-Tax refund for exports, Chinese steel prices will inevitably go up. Some mills have already asked for a $30 /mt price increase. A number of countries in the Middle East will keep the prices for various steel items, such as rebars, stable. The stratospheric price for crude oil will ensure more drilling activities in the US, keeping the pipe-and-tubing market strong. This, in turn, will prevent any dramatic price deterioration for flat rolled products. And do you really forecast a big economic slump in the US any time soon? All indicators point to an expansion, albeit not an expansion at the same pace we witnessed in Q1. Mr. Gloom: The US Economy looks great as a snapshot, but anyone who understands the US economy will tell you that a lot of the US economic growth is coming from the housing sector. When interest rates were low, the real estate boom added a full point to annual GDP growth and added many jobs in construction, remodeling and real estate services. But in the process, Americans took on $2 trillion in loans, unfortunately, mostly through adjustable mortgage rates and exotic loans such as "no interest" and "negative amortization" loans. With more affordable borrowing, housing prices soared by 50 percent to 100 percent in the hot urban markets. Now the interest rates are going up because the Fed is worried about overheating and inflation. So, the party is close to being over. There is significant overbuilding going on, especially with condos. The builders have started to discount them,but there are no takers. Certain markets such as Miami, Las Vegas, Boston and San Diego are ice cold, and others such as Los Angeles, Chicago and New York are not so far from freezing. I remind you, rents and incomes didn't go up nearly as much as the property prices, and some earlier adjustable mortgage rates are now going into a higher rate, making mortgage payments unaffordable for many home owners. We can, at best, hope for a soft landing and for property prices to remain flat for many years. But I predict that as the real estate investors and speculators exit, there will be glut of unsold houses and condos and we will hit the ground hard. That will be the end of home building and commercial construction. So will be the end of many well-paying jobs, new cars, appliances purchases and urban sprawl - where most of our steel is consumed. Mr. Bull: The housing market is without question under pressure. But time and time again, it has shown its resiliency. One month of weak housing starts is followed by another month of unexpectedly high housing starts. Mortgage rates are still relatively cheap. Furthermore, commercial buildings and infrastructure projects are still thriving. The steel supply is still tight, and demand will stay solid. Other markets are still strong, which will keep prices high, and domestic mills will take advantage of this higher pricing plateau. Mr. Gloom: In every bubble economy there will be nervous ups and downs, but the end result is inevitable. Sooner or later the bubble will burst. It's simply not reasonable to think that property prices will go up by over 50 percent when the incomes haven't gone up. As you know, America is very debt-happy country. Consumers are heavily in debt with credit card and mortgages. The American government has the largest debt in the world, and is still spending like there is no tomorrow. This reckless spending can't go on for much longer and will have a sad ending in the near future. What does this mean for you and me? Last year we had continuous demand, but due to the weakness of other regions, prices suffered. But buyers continued their usual buying, alas, at bargain prices. If US demand slows down as well, the prices may drop dramatically and at a catastrophic rate. 2005 has been a tough year for many traders. Companies that were caught with wrongly timed purchases suffered millions of dollars in losses, and people lost their jobs over these bad purchases. My advice: watch out and don't always follow the herd blindly; they may lead you off the cliff. Mr. Bull: How right you are! Economic symptoms, such as the state of the housing market, occur on a regional basis. Expensive markets such as California and some East Coast regions are more susceptible to market fluctuations than other regions in the Southwest or in the heartland of the country. Yes, we are very much a consumer-driven economy. The US consumer has been spending too much for many years now and the naysayers have been pointing to the bursting spending bubble for a long time. But did the spending bubble ever burst? There are always incentives and if certain goods / services make sense to the consumer, then they will buy them. Witness the increased numbers of car sales, driven by the demand for fuel-efficient vehicles or by the new hybrid models. The foreign transplants are leading this movement. Honda and Toyota are opening plants as fast as the traditional US car companies are closing some of theirs. But don't count out GM, Ford and Chrysler just yet. All of them have seen the light and will pump vehicles that the consumers want into the market at a furious pace. Finally, the US will be building a very long fence (several thousand miles) soon. A lot of steel will be required. Mr. Gloom: Actually, this is one case that I don't want to be right. I would like this economic expansion and robust steel market to continue forever. But we both know this will not happen. We are probably safe for another quarter or so. In the mean time, large import shipments are arriving and prices are still heading up. Once we reach the peak this time, the downward slope will not be pretty. Until then, enjoy the ride!

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