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Scrap-iron ore price link weakened by trade tensions, Turkish downturn

The traditionally strong correlation between ferrous scrap and iron ore has been eroded by global trade upheavals and economic troubles in Turkey, the largest import market for steel scrap.

Previously, the relationship between ferrous scrap and iron ore prices often meant price movement in one would lead to a corresponding price change in the other – with market participants trading on this correlation.

Between 2014 and 2016, the relationship between iron ore CFR China and heavy melting 1/2 (80:20) steel scrap CFR Turkey – respectively the global benchmarks – was robust, showing a correlation of 87.3% for that time period.

Over 2017 and 2018, the correlation weakened considerably until it showed signs of a decoupling this year.

In fact, the correlation in 2019 to date was not only weak, but negative, as the rally in iron ore prices following several supply-induced bottlenecks saw no corresponding bullish move in Turkish scrap prices, which slipped by almost 15% since the beginning of the year.

This result does not change even if one accounts for a potential time lag of price effects on the other raw material.

The decoupling of scrap and iron ore price movements appears to be largely driven by trade-related factors and developments in the Turkish domestic market, which are somewhat insulated from the wider market dynamics.

The Turkish domestic market has seen a 35% slump in steel consumption in the year to date, with sales of domestic passenger and light commercial vehicles down 45% and total house sales down 31% in May on the year, ODD and TUIK data showed.

Turkish steelmakers subsequently focused on the export market. But despite scrap-consuming electric-arc furnaces in Turkey becoming more competitive off the back of higher iron ore prices, this did not translate into dramatically higher export sales and has not notably supported scrap prices.

This was largely due to greater protectionism and safeguards – artificial barriers to Turkish finished product exports into markets like the US and Europe, which raised import prices and capped sales volumes.

Scrap import prices into Turkey have declined by 14% since the beginning of the year. This slide has come on the back of a 10% drop in crude steel production and a 16.5% drop in Turkish scrap imports – representing almost 1.5 million mt less scrap imports – in H1 2019), as well as finished product pressure in remaining export outlets and domestic markets.

Turkey’s dire market situation thus contributed to a breakdown of the correlation this year.

Iron ore price moves

Despite the breakdown, market sources still consider the relationship between scrap and iron ore helpful to understand and anticipate market dynamics.

“I still look at iron ore as a lead indicator for scrap, although [it] has broken out,” one futures trader said, adding that especially for short-term sentiment the relationship is still useful.

Another physical trading source said that the depressed situation in Turkey hides the fact that iron ore’s price strength over the first of half of the year also lent support to scrap. “Scrap is much more expensive than it should be. If iron ore was at $60, I would [expect] scrap at $240-$250 levels, not $270-$300 levels,” one European trader said.

In fact, the reversion of iron ore prices below $90/mt CFR China this month – in line with pressured scrap and finished product prices – attested to the still persistent correlation between the two steelmaking raw materials, a London-based paper trader said.

Nonetheless, on the back of the weaker correlation, some traders have instead focused more on finished steel price movements that have a close link to both Turkish scrap and iron ore imported into China.

Cues from finished steel

One broker said that traders working through him now “look at Chinese rebar more,” to inform scrap trading decisions.

Long steel prices in Asia have a direct impact on iron ore prices in the region – largely produced via blast furnace – and a close link to Turkish rebar prices. This is because South East Asia remains one of the few outlets for Turkish finished steels that is not subject to any notable protectionist measures.

Similarly, traders of financial contracts now closely watch both the recently launched London Metal Exchange hot-rolled coil contracts for China and the US, which show a strong correlation to both Turkish scrap and the corresponding LME contract and US scrap.

Like Turkish scrap, US scrap also showed little parallel movement with iron ore this year to date, but instead showed a stronger correlation with US HRC price developments.

And like Turkey, the US also showed a more insulated price development for raw materials and finished products in its market over the last year, amid protectionist measures.

Should these trade conditions change once again in the coming months, as some market participants already anticipate, the correlation between scrap and iron ore pricing would be likely to regain its former strength.

Source: S&P Platts

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