Steel And Aluminum On The Negotiating Table

Summary

• Tariffs and protectionism are bearish for the dollar and increase costs of commodities.
• The President turns to trade to keep campaign promises.
• A divided administration.
• A giant bluff?
• U.S. Steel is in a good position, but the shares have come a long way.

Last Thursday, after a meeting with the CEOs of America’s leading steel and aluminum producing companies, the President shocked markets. President Trump announced this week he would sign an order imposing a 25% tariff on foreign steel and 10% on aluminum that comes into the United States from other countries. The move, to support U.S. production, is the next step in the President’s plan to level the playing field when it comes to global trade. On so many occasions, on the campaign trail and after the election, multilateral trade agreements and previous deals have been in the crosshairs of President Trump’s plans to put America first. In Davos, Switzerland early this year, the President told other world business and political leaders that making America first did not mean America alone as growth in the world’s wealthiest nation translates to growth around the globe. However, the President demanded a reform of the international trade system to make it “fair and reciprocal.”

Last week, the first concrete action of the administration was to raise the immediate threat of tariffs on two strategic metals and building blocks for infrastructure. Stocks moved lower after the announcement and the dollar reversed from a rally that took it to a new short-term high. The leader of the free world fancies himself as a master negotiator, and there may be more to last week’s announcement than meets the eye.

Tariffs and protectionism are bearish for the dollar and increase costs of commodities

Stocks dropped hard after Thursday’s announcement, and it was another ugly week in the equities market. After beginning the week on a high note, Thursday’s announcement exacerbated selling in equities on Tuesday and Thursday as the ramifications of tariffs on steel, aluminum, and other potential imports began to filter through the market. Tariffs amount to taxes for consumers and automobile manufacturers and many other companies in the U.S. will likely wind up footing the bill for higher priced raw materials. The upside comes from steel and aluminum producers and their workers as they could see an increase in profits and employ more workers. However, the cost is likely to weigh heavily on U.S. consumers who will see their cost of goods sold rise.

Tariffs tend to distort free markets as they are antithetical to the theory that the most efficient producers of a commodity rise to the top and do the most business. However, the other side of the coin is that when other countries wind up dumping raw materials on the U.S. market at cheap prices, it makes it virtually impossible for the American manufacturers to compete. The President has spoken a lot about a level playing field but the ramifications of tariffs on the ferrous and nonferrous metals, and potentially other imported goods, could weigh on markets across a wide range of asset classes. The fall in equity prices is one example. The value of the U.S. currency is another.

Source: CQG

As the daily chart of the U.S. dollar index shows, the greenback fell to a new low on February 16 when the index found a bottom at 88.15. On that day, the dollar posted a bullish key reversal trading pattern on the short-term chart and followed through on the upside. The index moved above the first level of technical resistance at 90.455, the February 8 high and continued to climb reaching 90.885 on Thursday. The announcement of the tariffs appeared to stop the recovery of the dollar dead in its tracks, and it closed on Monday, March 5 at around the 90 level, close to recent lows.

The President turns to trade to keep campaign promises

President Trump won the 2016 election with an anti-globalist message that put America first. His base of supporters in the steel mills, coal mines, and other industrial states he carried in the election, have been waiting for his to level the playing field and create more jobs and profits for U.S. industrial companies. The tariff announcement came as a shock to markets, but a boost to his supporters.

So far, since Inauguration Day in early 2017, the Administration has attempted to change the health care system, but a divided Congress and elements within the Republican Party prevented a victory and chance to fulfill one of his many promises. On immigration reform, the President resorted to executive orders has faced numerous court challenges from the states. Tax reform at the end of last year provided a major victory for the administration, as have appointments and orders to cut regulations across the country. While the President has not succeeded in keeping all of his promises, he has made attempts and fought the battles resulting in some victories, some losses, and some issues where the jury is still deliberating. A level playing field for U.S. business is another issue from the campaign that the commander-in-chief has decided to address at this time.

A divided administration

Tariffs leave a bad taste in the mouth of many economists and politicians. Students of history remember that it was tariffs in the 1920s that led to a stock market crash and the Great Depressions that lasted into the 1930s. Therefore, the issue of tariffs has divided Congress, and even those within the President’s party have voiced disagreement. Moreover, some of President Trump’s most loyal supporters have taken the other side of the argument. It appears that Gary Cohen argued passionately against the protectionist policy and failed. Some in the press believe that it will not be long before the ex-Goldman Sachs President resigns from his post and returns to the private sector. Larry Kudlow, an informal advisor to the President, and potential replacement for Cohen also disagrees with the tariffs and stated his dismay on CNBC last Friday.

The President ran on a platform that he is trying to execute, but we need to remember that one of the attributes he repeatedly professed was that he is a master negotiator who wants to do deals.

A giant bluff?

I found it interesting that the announcement of tariffs came without an executive order and signature and the administration said it would be coming next week. The order of events has set up a window for rapprochement between the U.S. and countries that the tariffs will directly impact. Canada, South Korea, Mexico, Brazil, China, Russia, Germany, and the United Arab Emirates stand to lose the most on the steel and aluminum tariffs. It is entirely possible that there is lots of horse-trading going on behind the scenes between the President’s emissaries and these countries for what could be a great compromise.

Henry Clay was called the Great Compromiser and to paraphrase him; he said that in any compromise worth its salt, both sides have to go away from the table unhappy. It is entirely possible that the President left a window of time for a deal that would improve the position of the U.S. when it comes to global trade in steel and aluminum. A strategy of behind the scenes negotiating would achieve two goals. First, it sends a strong and confident message to the President’s political base that he is keeping his promises. Second, it would avoid the ramifications of tariffs, retaliation by other trading partners, and solve the discord within his administration. If President Trump pulls off a last-minute deal to avoid tariffs, he will cement himself as the master negotiator via a deed rather than a promise.

U.S. Steel is in a good position, but the shares have come a long way

U.S. Steel (NYSE:X) is a company that appears to be in a no-lose situation when it comes to the tariffs issue that rose to the surface last week.

Source: Barchart

As the chart illustrates, U.S. Steel shares fell to a low of $18.55 last May and over the course of ten short months, rose to a high of $47.64 last week. The price of the shares moved more than two and one-half times higher which was an impressive move. While it is possible that X will retreat from its current lofty level if steel prices were to move lower, the company now finds itself in an enviable position because of last week’s announcement by the President. If he signs the order to put tariffs in place, U.S. Steel will own the lion’s share of the domestic steel business. The next initiative for the administration appears to be a $1.5 trillion. Infrastructure rebuilding package which will require lots of steel that will now come from U.S. producers and X will lead the pack. At the same time, if the President’s move was just a giant bluff and he achieves a better trade deal leading to a more level playing field, it will also benefit the future business for U.S. Steel. I am not a buyer of this stock at the current lofty level but would not be a short-seller. Instead, I would be a buyer of X on a dip, or a seller of put options on the stock if the price were to retreat into the high $30 range.

I believe it is possible that there is a lot more behind the scenes arm twisting over trade that is occurring before the President puts pen to paper on the tariff issue. Time will tell, but if a deal is reached without the use of protectionist measures, it could be the most significant victory for President Trump yet.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

Comments

[TheRod1]

China is so concerned about these tariffs, they have decided to put 3,000,000 of their best men in it.

[R. Brown]

Andrew, Very interesting read, Thank you for your thought provoking article. US Steel will of course benefit from any steel tariffs against the rest of the worlds steel imported into the states. I think that all the steel producers will benefit as well.

I think the real benefit will be in the producers of raw materials to produce steel. There are already mines for MET coal, which is exported around the world, iron ore pellets mined and refined out of the iron range in Minn. Many other components for making steel still available in the states.

Aluminum is readily recycled, price paid for scrap alum cans at my local scrap yard has been in the .35-.40 per lb for years. In the 90s it was widely reported that if US recycled scrap soda cans we would not need to import aluminum. That may have been true back then but we did not so now we import, garbage dumps and landfills will be the future goldmines.

Intellectual property "rights" what Apple phones, movies ...doubtful value in a real world full of material needs.

[zito]

Trump's trade move against China although unpopular in the investment community is very popular with the general public. I am in favor of getting China to negotiate free trade.
Although I don't think steel is very important to our economy; technology and intellectual property rights are very important.

[buddyrow4]

🤔

[davidtg401]

Trump did basically say in tweets that the threat of tariffs would be used as leverage to renegotiate NAFTA which was part of his campaign rhetoric. So I'm looking at it as a bit of a bluff now but he could still follow through with them....

[Ben Gee]

If the US follow through with tariffs, it will create a lose-lose situation.
The US and trading partners will be worse off.

[sid gold]

Andy
Another great professional article
I completely agree
Most likely Trump was placing a shot across the bow and will not actually do as much especially to Canada n Mexico
His North Korea stance seems to be bearing fruit as North n South are talking

Thanks again

Sid