Trade conflicts are derailing the steel business.
Steel prices are down 19% year to date, while the cost of scrap steel has fallen 14%. As prices fall, steelmakers are cutting output, and buyers are hesitant to add to their inventories for fear of missing out if prices go even lower. Both buyers and producers are hesitant to call a bottom as the industry waits in vain for positive news.
“Buying activity remains subdued across most product categories,” wrote Cowen analyst Tyler Kenyon in a Tuesday research report.
Understanding why requires a look at how the industry works. Demand isn’t always about the number of cars or bridges being built. The U.S. doesn’t produce enough steel, meaning America has to import tons to meet demand.
Prices are volatile now because tariff rates are changing—the U.S. this month eliminated tariffs on Canadian and Mexican steel, as well as halving them on steel from Turkey—and because middlemen in the industry are cutting their inventories.They have to do that because if they buy steel now, when prices could fall tomorrow, they might have to sell at a loss next week. No one wants to be holding high-price inventory when prices plummet because of an external factor like trade negotiations.
“Paralyzing trade uncertainty [is] said to be weighing on buyer appetite” following the shift on tariffs for Canadian, Mexican, and Turkish steel, Kenyon wrote. He said buyers he has contacted are holding back as prices fall.All the uncertainty is affecting production. ArcelorMittal, the largest steel producer in the world, announced cuts to output in Europe that build on reductions it disclosed on May 6.
“This is again a hard decision for us to have taken but given the level of weakness in the market, we feel it is the prudent course of action,” said Geert van Poelvoorde, CEO of ArcelorMittal ’s European flat-products business, in the company’s news release. “This will be a temporary measure that will be reversed when market conditions improve.” The plan affects steel mills in France, Germany and Spain.
A lot of bad news is already reflected in the share prices of steel producers. ArcelorMittal is down 25% year to date, and U.S.-based steelmakers aren’t faring much better. United States Steel (X), Nucor (NUE), Steel Dynamics(STLD) and AK Steel (AKS) are off 13%, on average, so far in 2019, far worse than the 8.7% gain in the Dow Jones Industrial Average.
It isn’t clear what might turn things around. “More prolonged mill [inventory] destocking, particularly in the Midwest, is expected to exert more downward pressure on June scrap despite a modest recovery recently in export demand,” says Kenyon.
Scrap is a key raw material for steel making, so scrap prices often lead steel prices higher or lower. If scrap prices drop, as Kenyon expects, steel prices will be stuck at current level (or worse).
That means steel investors should stay defensive.
Nucor and Reliance Steel & Aluminum (RS) are Kenyon’s top picks. Nucor is a low-cost producer of steel and Reliance doesn’t produce the stuff. It is a service center, or middleman, that makes a small margin processing material and holding inventory for downstream steel users. His target price for Nucor stock is $64, up 25% from recent levels. For Reliance, his target is $100, up 19%.
It has been a strange year for steel. Iron ore, another key raw material, is up more than 50% year to date because Vale (VALE), one of the biggest producers in the world, had to suspend output at a number of mines after a tailings dam collapsed at one of its operations in Brazil, killing hundreds.
Yet Turkey, usually a big purchaser of American scrap, hasn’t been buying, partly in retaliation over U.S. trade actions.
The net effect has been a surplus of raw materials in the U.S. Domestic steel prices have dropped even though iron ore has skyrocketed. It’s another example of trade policy-making it difficult to trade stocks in 2019.
Sources : Barrons