Weekly Market Update - January 14, 2016

Scrap Price Benchmarks: There are three benchmarks that we use in this report to monitor the price of scrap. These are the IODEX price of iron ore delivered North China, the value of the US $ and the price of oil in Cushing Oklahoma. The price of ore and the value of the US $ have a direct causal effect on scrap prices. There is not a causal relationship between scrap and oil but they are both global commodities with a highly correlated price ratio. Comparison with these benchmarks has enabled us to signal whether the price of scrap is out of line either on the up or down side. The price of Chicago rose by $30 in January to $190 / gross ton, down from $334 in January 2015. Fig. 1 shows the IODEX, (62% Fe delivered N. China) and the price of scrap through January 9th. The correlation since January 2006 has been 0.8292. In the period 2007 through 2009 the correlation was 0.9182 but the relationship became de-coupled in 2010 and 2011 when the big 3 ore cartel began to eliminate long term contracts. There was a similar decoupling in the other direction up until the 3rd Q of 2015 caused by the oversupply of ore. In October the price of scrap came back exactly into line with iron ore and since then the January scrap price increase has caused the lines to separate again with scrap looking overpriced. We have superimposed the Goldman Sachs forecasts on this graph and show that the prediction for the price of ore in 2015 made in August 2013 turned out to be very optimistic. In January 2015 GS forecasted the price would be $70 in 2017. The latest price we have from Platts was on the 11th when the price was $39.01 In the long term, Chicago shredded has been 3.3 times as expensive as the IODEX on average with quite a wide spread in each direction. For four years through December 2013 scrap was advantageously priced on a historical basis compared to ore. Throughout 2014 scrap became increasingly uncompetitive and in July this year reached a high of 5.2 x the IODEX, (Fig. 2). The latest scrap price increase and iron ore decrease caused the ratio to jump from 3.97 to 4.87. The divergence from the long term average is part of the reason why China with its high dependence on ore as a raw material has been able to disrupt the global scrap market by selling low priced semi-finished. Fig. 3 is a scatter diagram of scrap and ore and where we are this month. Fig. 4 shows the scrap / US $ relationship which has a 0.8882 negative correlation since January 2002. An appreciating $ has a negative influence on the price of global commodities, of which scrap is one. At the present time by this benchmark, scrap is undervalued. Fig. 5 shows the scrap / oil relationship through January 13th with a correlation of 0.9270 since January 2000 and 0.9378 in the 25 years since January 1990. Oil was reported to be $30.50 / barrel on January 13th. It was clear in December 2014, that if history was a guide, scrap was headed for a fall and this occurred in February. Scrap followed oil down for all of 2015. In January we have an unusual situation where scrap and oil are moving in opposite directions. As of now scrap is overpriced compared to both oil and iron ore but underpriced compared to the broad index value of the US $.

Fig 1

Fig 2

Fig 3

Construction Put-in-Place – Infrastructure: Fig. 6 shows infrastructure spending (constant $) from 2010 to present. After a lull since the recession ended, spending levels are trending higher, with 28 consecutive months of y/y growth reported from the US Department of Commerce. Infrastructure spending CPIP at the State and Local level increased 7.4% for the 12 months ending November 2015 to $10,959 million. On a 3 month y/y the growth rate declined to 5.6% and in the month of November it fell further to 2.8%. Thus the overall growth trend is negative, Table. 1. Seventy percent of infrastructure spending goes into highways and streets with two thirds going to pavement and the remaining one third to bridges. The trend for each of is trending higher. Sewage and waste projects saw the largest growth at 11.8% y/y, however 3 month y/y growth fell to 4.9% and November posted a negative 0.3%. Water supply and conservation are showing softening growth trends, Table. 1. President Obama signed into law a five year $305 Bn highway bill on December 4th of last year. The bill calls for $205 Bn in highway funding with $48 Bn earmarked for transit projects. It also reinstates the Export / Import bank. This five year bill ends a 10 year string of stopgap funding that has impacted State’s ability to start projects with scopes exceeding two years. The new law is known as the FAST Act which stands for Fixing America’s Surface Transportation Act. It will be funded by a national gas tax of 18.4 cents per gallon plus so a package of $70 Bn in offsets from other areas of the Federal budget. The passage of this long term spending bill should result in the initiation of larger scale, longer term projects which is a positive news for the steel (construction), industry.

Fig 6

Table 1

Net Job Creation by Industry through December 2015: There was a net increase of 292,000 non-farm jobs in December, which was better than economist’s consensus expectations. October was revised up by 9,000 and November up by 41,000. The three month moving (3MMA) of gains through December was 284,000. Monthly job gains, seasonally adjusted have averaged 221,000 per month in the twelve months of 2015, (Fig. 7). Total nonfarm payrolls are now 4,877,000 more than they were at the pre-recession high of January 2008.

Table 2 slices total employment into service and goods producing industries and then into private and government employees. Total employment equals the sum of private and government employees. It also equals the sum of goods producing and service employees. Most of the goods producing employees work in manufacturing and construction and the major components of these two sectors are also shown in Table 1. In December, 275,000 jobs were created in the private sector and 17,000 in government. Since February 2010, the employment low point, private employers have added 14,068,000 as government has shed 475,000. In December service industries expanded by 247,000 as goods producing industries added 45,000 people. Since February 2010, service industries have added 11,569,000 and goods producing 2,024,000 positions. Table 1 shows that manufacturing gained 8,000 jobs in December. In all of 2015, manufacturing has added 25,000 jobs. Note the subcomponents of both manufacturing and construction shown don’t add up to the total because we have only included those that have most relevance to the steel industry. Primary metals lost 2,800 jobs in December, is down by 4.6% in the last 12 months and has not had a single positive growth month in 2015. Motor vehicles and parts lost 2,400 jobs in December, oil and gas extraction has had negative job creation in all four time periods examined in Table 1. Truck transportation gained 5,300 jobs in December and is up by 1.3% in 12 months. Construction added 45,000 jobs in December for a total of 128,000 in the 4th Q and 263,000 for the year. Construction continues to move ahead of manufacturing as a job creator but it must be recognized that productivity increases in manufacturing are very much greater than they are in construction. Construction has added 1,038,000 jobs and manufacturing 878,000 since the recessionary employment low point in February 2010. Based on the total construction analysis that we report in our CPIP update, we assume that construction jobs will continue to expand vigorously. Construction has been holding back steel demand but that should increasingly not be the case.

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Table 2

Currencies: The U.S. Dollar Index came in at 124.50, nearly three years with a value exceeding 100. With weak foreign economics, the Index has steadily climbed to levels not seen since the beginning of the economic expansion in the early 2000s. It has strengthen 10.2% on a y/y basis and has also climbed 4.6% in the last three months and nearly 3% in the past month alone, (Table 3).

A strong economy, relative to the rest of the world, has helped the Dollar strengthen to its strongest level in twelve years. The Dollar strengthening makes scrap from the U.S. less attractive to buy on the global market and steel less attractive to buy from the U.S. Other major economies that rely on strong oil prices have also helped create an appreciative environment for the Dollar.

The Canadian Dollar has weakened roughly 17% on a YoY basis and 9% in the last three months. The Canadian Dollar, also called the loonie, has dropped to $1.42 per U.S. Dollar, or equivalently, $0.70. This is the lowest value in nearly thirteen years. The Canadian economy has been tumultuous over the past two years as it’s tied closely to oil prices, which have dropped from $105 to $30 a barrel in the last year and a half. The outlook is not kind as the forecast for WTI crude oil is projected to drop below $20 a barrel by 2017. The Bank of Canada is widely expected to cut interest rates in their next meeting to help keep the economy afloat. The IMF’s latest projection in October has the Canadian economy expanding only 1.7% in 2016, 0.4 percentage points lower than the previous forecast in July 2015 (International Monetary Fund).

Table 3

Federal Reserve Beige Book Summary: The Federal Reserve’s January Beige Book summarizes that economic activity expanded for a majority of the twelve districts for the fourth quarter, roughly the same amount of time since the last Beige Book release. The descriptive tone for growth among the districts ranged from modest to moderate growth; similarly, outlooks remained “upbeat” for the reporting period. Consumer spending varied across the Districts with slight increases as a result of typical holiday spending. Manufacturing also experienced a slowdown in activity across most Districts attributed to weak demand for energy and a precipitous fall in oil prices. The data for nonfinancial services show a continual expanding sector across the districts, most notably demand for the service sector in the Dallas, Boston, Kansas City and Minneapolis Districts.

Districts reported mixed conditions in manufacturing activity with five districts reporting a slowdown: New York, Philadelphia, Kansas City, Atlanta, and Minneapolis. Somewhat surprisingly Dallas reported an increase in demand despite the complete falloff of oil prices. Commercial real estate demand, along with commercial construction, showed an uptick in most Districts with Dallas reporting strong numbers for construction. The labor market continues to strengthen despite the lack of wage pressure with some Districts noting a shortage of skilled workers. Typically this would mean a rise in wage growth pressure as firms would pay higher wages for skilled workers as the talent pool dwindled. Most districts indicated employment increases and six districts, whom experienced minimum wage increases in recent months, saw an increase in wage pressure and a labor shortage. Despite these recent developments in wage pressure, a majority of the Districts stated that overall price pressure was negligible (Federal Reserve).

Federal Reserve

U.S. Steel Capacity Utilization: Raw steel production got off to a slow start for the first two weeks of 2016, averaging just 1,517,000 tons per week or 64.5% capacity utilization. The utilization rate for the last 12 weeks has averaged a slightly better 65.1%. Raw steel production totaled 87,753,000 tons in 2015 for an average weekly production rate of 1,688,000 tons and a capacity utilization rate of 70.9%, Fig. 8.

Fig. 9 shows the impact of imports on US raw steel production. It is clear from this chart that production volume and therefore capacity utilization has been negatively impacted by surging import levels. Looking at this statistically; from 2010 to 2014 the correlation coefficient between the two data sets measures 0.749. From 2014 onward at which point import levels rapidly surge and the c.c. falls to 0.467.

Fig. 10 presents a long term relationship (2000 to present), between jobless claims (reverse scale) and raw steel production. From 2000 to 2012 the correlation coefficient between the two data sets measures 0.889. From 2012 to present the c.c. plummets to 0.121, Fig. 11. The overall US economy is creating jobs causing jobless claims to decline. The steel sector is not participating in this job growth. On the contrary steel jobs are being lost as a direct result of the massive import surge.

Fig 8

Contributors this week include; Bryan Drozdowski, Peter Wright and Steve Murphy