Mike Norman, HardAssetsInvestor.com (Norman): Hello everyone, and welcome to HardAssetsInvestor.com's interview series. I'm Mike Norman, your host.
Well, after doubling in price, steel has come down sharply – in fact retracing all of its gains over the past few years in very short order. Here to talk about the outlook for steel is Paul Quartararo. He is a partner with SPECTRA Resources. Paul, thanks for coming back on the show. It's good to have you.
Paul Quartararo, partner, SPECTRA Resources (Quartararo): Thanks for having me.
Norman: Well Paul, the last time you were here we were talking about the strength in the steel market. You at that time were looking for higher prices, which indeed happened. But you also said that looking somewhat further down the road you were looking for a peak. I don't think you were expecting anything as severe as what we've seen, but tell us about it. We saw a doubling, and then just in the past five or six months, steel prices have retraced all of the move that we saw in the prior five years, right?
Quartararo: Mike, it's been really an incredible year. Last time we met, prices were around $580 a metric tonne. In the peak, in the summertime, probably in July, the price of steel went to $1,200 a metric tonne for hot coil rolled steel. Since that time, the prices have completely contracted, and now we're back at levels below that $580 a tonne.
Norman: Below. So even more than the move we saw in the run-up?
Quartararo: That's right.
Norman: Nobody really expected that. I mean, we've seen it throughout the entire commodity complex, maybe with the exception of gold, which has held on to most of its gains. Severe retracement – and in the case of steel, I guess we can understand why. It was the global economic slowdown, the credit crunch, etc. But did anyone in the industry expect it to come down, not just all the way, but even lower than where it was when it started off?
Quartararo: No; I mean, the philosophy this time has been that, when the prices were going up, that due to consolidation in the steel industry, there would be more discipline in the price on the way down, and it wouldn't come down as much. But that all went by the wayside once demand dried up due to the credit crisis, and prices just continued to slide down at a very bad pace.
Norman: Now one thing that may be a very significant factor: We still hear about economic growth in China – it's throttled back. Here in the United States we're in a recession. But the automobile industry – talk about that. The automobile industry is probably the main source of demand for steel, and the automobile industry has gotten clobbered. Clobbered!
Quartararo: That's absolutely right, and everybody knows what's happening in the auto industry right now is a very serious problem. Steel is going to be affected, as far as buying is concerned. And what the steel mills have done domestically and abroad is they have reduced their capacity tremendously. Here in the United States we have about 30 blast furnaces that could create steel from raw iron ore. Right now, they've taken out 19 of those 30 blast furnaces, which has reduced supply capacity by more than 50%.
Norman: Was the steel industry … I know in some of these other commodity markets, speculation and investor demand was an important element in total demand, outside of physical demand for the material. I don't think there's an exchange-traded steel contract. But you're in the business: Was speculation a factor in the run-up in steel prices, pushing things up as high as they got?
Quartararo: Yes, and everybody was really expecting this even before last year. During the run-up to the Olympics in China, the expectation was that there would be a strain on supply. Everybody was stocking up their inventories, and every time there was a price increase, people were running out to get more material to try to avoid the next price increase. But prices kept increasing, and people kept loading up on new material, and that just continued to drive the upward trend.
Norman: Is it driving it on the downward trend now? Are people selling it? Are they short? Are people selling the market, and is that acting as a pressure on prices? Is that one of the reasons why we are down past the point where we started?
Quartararo: Absolutely. Because starting in the fourth quarter, as prices started to retract and then demand sharply decreased, people are not going out and buying material. And that's going to actually help the industry in the near term. Because the stockists – who are the main purchasers form the steel mills – are all running at low inventories, and they haven't been buying, waiting for that bottom. And I think the bottom has arrived.
Norman: You do? You think the bottom has arrived?
Quartararo: Yes, I do.
Norman: And you talk about the de-stocking of inventories. Some of the fundamental backdrop is starting to get a bit more constructive, you say.
Quartararo: Yes. Right now, the domestic service centers are running on low inventories, and there has to be a point where you go back and restock. January/February is usually a slow time for construction. Outside the auto industry, there has to be a time when you go back and rebuild inventories. That time is coming, and I think we've reached the bottom on prices both domestically and abroad.
Norman: Well you were 100% right a year ago when you were here talking about the strength leading to a turnaround.
But now, as you saw that price pattern when you were here a year ago, you say now you’re looking at it a little bit more constructively, with some bullish fundamentals quietly coming into play here. What I wanted to ask you about is the stimulus package, which will be forthcoming, and is going to include a hefty dose of government spending on infrastructure. I mean, just as an observer, that would suggest to me you’re going to need a lot of steel. How does that play into the mix?
Paul Quartararo, partner, SPECTRA Resources (Quartararo): Traditionally, in the past, the automotive industry was the primary indicator of what was going to happen in the future of the economy, whether it’s going to come back or go down. That has changed, obviously, and now people are looking toward steel because steel is used in everything. It’s used in highways, bridges, hospitals, appliances. So people are now looking toward the industry to see when the [economic] comeback is going to happen.
Right now, the domestic steel industry in the U.S. is lobbying the current administration for $1 trillion over the next two years in an infrastructure package. I don’t know if we’ll get the $1 trillion, but there will be something hefty to contribute to infrastructure. That takes a little time, but it would put basically a strain on supply in the future for steel if that does come to fruition. [Editor’s Note: This interview took place before details of the Obama administration’s stimulus package were released.]
Norman: Now it puts a strain on supply for what reason? Is the domestic steel industry saying hey, this has got to be all our stuff, we don’t want any imports? Or is it going to be the market’s open from wherever we can source the stuff?
Quartararo: Well right now, the domestic steel industry is lobbying the U.S. government to specify that it should be U.S. steel only. That would be a tremendous mistake for the taxpayers because you make it U.S. only and they can charge whatever they want; your bill is going to be a lot higher than it would have been if you had that competition from foreign supply. My suggestion would be – I don’t know it they would take it – but my suggestion would be to specify a percentage - let’s say it’s 30%, 40% or 50% – and that has to be U.S. steel only. This way you’re helping out the domestic steel industry but yet you’re still letting in the competition to keep prices fair.
Norman: Now what happens if we don’t get the trillion? The estimates now are in the eights – $825-$850 billion. What happens if it comes in on the low end? What happens if it comes in at $500 billion or $600 billion? Is that less bullish? Would we have to wait longer to see the steel market work out its excess?
Quartararo: I don’t think so. I think that there will be a stimulus package. Fundamentally, whenever an economy is struggling, the first thing they try to do is invest in infrastructure for the long term, because it takes time for that money to be funneled into the economy. So I definitely think that there will be a stimulus package for infrastructure, and even if it’s lower than expected, right now in the domestic steel industry, the United States demand is 100 million tons a year.