ISM index signals positive/negative news; Fed stays cautious

We think that the ISM Manufacturing Index is an important leading indicator for our industry, and not unlike the manufacturing component of the Industrial Production Index (another favorite of ours,) we’re pretty sure the ISM signals both positive and negative news for the metalworking industries in general and scrap in particular.

Anyway, this week’s May number increased to 42.8 with all components, other than employment that is, in positive territory. The new orders index, for example, came in at 51.1, the highest in 18 months. Also, as we’ve previous noted, anything above 41.2 signals overall economic expansion, according to the Institute for Supply Management. This index is said to lead the overall economy by about four months.

We also saw this week that construction spending unexpectedly posted its biggest increase in eight months in April, while personal income came in with its largest increase in 11 months, and pending home sales were surprisingly strong. Even May auto sales, at 9.83 million units, faked out those who were expecting a lot less. All good stuff although April’s factory orders and the ISM Services report disappointed, but sentiment improved following yesterday’s drop in jobless claims–a first in 20 weeks.

And while some see this and other recent reports as a confirmation of a “V” shaped economic recovery, the Federal Reserve remains extremely cautious. If anything, the Fed is even more conservative today than they were back in January.

Minutes for their April 28-29th meeting has Fed officials projecting an unemployment rate between 9.2%-9.6% in the fourth quarter of this year with almost no improvement projected by the fourth quarter of 2010(!) As for GDP, the U.S. economy was expected to decline by 1.3%-2% in the fourth quarter from the year earlier period, again, a bit worse than their January projection.

It seems, however, that the current market is feeding on investor optimism, confident that economic expansion is either at hand or about to take off…”green shoots” of recovery and all that.

The counter argument is that what we’re currently seeing in commodities, for example, is just the very top of a bear market rally that has no where else to go but down. Sustained economic strength, as the argument goes, is illusionary especially with a domestic steel industry that’s stuck at about 45% capacity utilization, an auto industry that’s at a virtual standstill, on-going credit/financing issues, and rising unemployment.

Commodity prices, they say, are being led by temporary, aggressive Chinese buying, and most of that is for stockpiling, not for immediate consumption based on real demand. Thus, for some (many?) it’s difficult to reconcile signs of domestic economic recovery in the same breath that has the likes of GM and Chrysler in bankruptcy protection. And for those less convinced, there are still other shoes waiting to be dropped that, they say, will stall recovery and that include such items as fast rising credit card defaults, and a fresh wave of commercial real estate and private housing foreclosures, to name a couple.

In sum, for those in bear camp, the U.S. is believed to be in a cyclical upturn in an otherwise secular downtrend, while China, in contrast, is said to be in both a cyclical and secular uptrend. Thus, China’s recovery is viewed as real; the U.S. not so much…

Now, a look at the ferrous market

Purchasing magazine’s latest “Flash” report placed their Midwest hot-rolled sheet (HR) oil reference price for May at $392/net ton, the lowest they’ve seen since January ’04 and a whopping 63% below the July 2008 peak of $1,068/ton. And this, they believe, is not the bottom…their June forecast call for an average of $375/ton before increasing to $410 in July.

We also note, however, that this week AK Steel has upped its spot price for flat rolled products $20/ton for July delivery. That’s the first price increase we’ve seen since last July, prompted as much by cost pressure as opposed to product demand. Other producers are following. So, will it stick?

Goldman Sachs’ is surprisingly upbeat with respect to the domestic steel industry going forward, citing seven reasons for their fundamentally-appearing positive outlook, namely: historically low inventories; low imports; domestic steel prices that are below global prices; improving global macro-data; increasing steel utilization rates; production cuts that have exceeded the decline in demand; and, finally, the weak U.S. dollar.

As an early June reference price for spot HR, sources are quoting a range of $370 - $390/ton f.o.b. Midwest.

Scrap sentiment for early June, meanwhile, remains mixed with many anticipating little movement at best while others point to a continuation of a firming trend with scrap values having bottomed out in April. GFMS Metals Consultancy sees “some weakness in June” but also expects it to be “slight.” Many insist that exports will drive the market higher but with Turkey thought to be scaling back, so will scrap prices. East Asia is also reported as quiet. This week’s Scrap Price Bulletin is showing its No.1 HMS (heavy melt scrap) composite price at $186.17/gross ton, down slightly from a week ago. Chicago No.1 bushelings were placed at $216 - $217/ton.