We were somewhat surprised with this past week’s Market Survey where we found a reversal of trends we did not expect. One we reported on earlier when our SMU Steel Buyers Sentiment meter reading reversed its improving trend and declined by 7.5 points to -29.1%. Another trend reversal spotted was flat rolled steel inventory rebuilding at both manufacturers and service centers.

A second trend reversal we discovered in this past week’s survey was an end to the rebuilding of inventories by both service centers and end users. In our last Market Survey the number of manufacturers building inventory outnumbered those reducing by a 2-1 margin (24.7% vs. 12.3%). In this most recent Market Survey there no longer is a clear-cut move to either build or reduce inventory. The graph below shows 12.9% building, 71.4% maintaining and 15.7% reducing their inventory levels.

Service centers began rebuilding inventory in earnest in December and the trend continued through our Market Survey the week of January 18th when 20.6% reported rebuilding while only 8.8% were reducing with 70.8% maintaining. In this past week’s survey we are finding a much more active service center group as they adjust to their business results from January. In this survey 19.5% told SMU they were building inventory while 26.0% are now in a reduction mode – the balance of 54.5% are maintaining their inventories. As you can see there has been significant movement to reducing from those who were previously maintaining their inventories.

Why the sudden Shift?

SMU believes there are a number of factors in play which may be affecting the way companies are looking at their inventory and future inventory needs (i.e. buy now or wait).

Price

Since the 1st of December when the SMU Hot Roll Index (average) was $510 per ton ($25.50/cwt) prices have increased by $90 per ton to the current $600 per ton with the potential for further increase as many domestic mills are attempting to take their HR numbers over $600 per ton ($30.00/cwt). Galvanized pricing has increased by more than $100 per ton due to adjustments made in both coating extras and base pricing. Looking at base pricing alone the price trend was reversed in early November 2009 with base prices at $31.25/cwt (average). Our SMU base price average for galvanized as of this week is now $36.75/cwt – an increase of $115 per ton (plus additional increases for new coating extras).

Inability to Pass Price Increases to End Customer

As we reported earlier we are beginning to hear more companies complaining of their inability to collect all of the price increases. Of particular concern is the practice by some service centers and distributors of not pricing their product based on replacement cost. As a result the end customer does not get the true pricing dynamics for the current market. This clouding of the pricing picture presents difficulties for the end users as they try to determine where the true price trend is going and they tend to get “whipsawed” by various suppliers who may be looking for short term sales instead of doing what is in the best interest of the customer.

The thirst for market share by undisciplined or cash strapped service centers spread misleading or confusing prices into the marketplace. Those companies who are working off replacement cost and trying to compete with those who are working off something less than replacement have no choice but to lower margins or pass on the business. In either case there will most certainly be a discussion about pricing with their steel suppliers and a reluctance to accept further price increases and/or build inventory.

However, it is not only the service centers having problems attempting to pass through price increases. A manufacturer left us a comment after reporting they intended to increase steel purchases as…“An attempt to keep prices stable for a longer period of time. We have absolutely no leverage to increase pricing to our customer base in a market as price driven as this.”

Demand Concerns Remain

Demand is growing at a tepid pace although many consider their demand to be “flat” and both service centers and manufacturers continue to have difficulty forecasting future steel needs. This lack of sight is prompting steel buyers to maintain rather than speculate on future steel needs which may never materialize. In the graph below only 25% of the respondents reported they will increase steel purchases over the next three months.

A manufacturer provided some color about what they are seeing with their customers in today’s market – “Except for the price increases creating "fictitious" demand by pulling future purchases to current, reinforcing the price increase trend, our business is down….”

Speculative Buying & Rebuilding has been Achieved

Restocking without customer orders and/or inventory Speculation is over. We heard during our conversations with buyers this week as well as in our Market Survey comments that purchases (and/or business levels) were higher in November and December and January saw a drop-off in sales. One service center/trading company left us the following comment in this week’s survey, “It appears many took advantage of Dec/Jan mill and service center deals and hedge bought. Many may be covered until spring or as far out as May.”

This past week SMU spoke with a Midwest service center who advised us they handled customers in virtually all markets (including automotive) in their geographical area. Their comment to us was, “The new mill increases are not bringing buyers into the market. The mills tell you things are better than they really are….”

In Texas a large service center told us business was “very average” and they had purchased in November and December and would not buy again until at least May. We “don’t have much on order and we are not speculating at these levels….”

39% Failed to Meet January Forecast

In our most recent Market Survey we probed those responding to see if their company met their sales projections for the month of January 2010? With almost an even split of companies responding being manufacturing companies and service center respondents the result was 39% of the companies failed to meet projections – while 47.4% did meet projections and 13.6% exceeded projections.

Lack of Confidence

As Mr. Goncalves so eloquently pointed out during the Metals USA earnings conference call with analysts, “…You only build inventory when you have the confidence that the mills will protect inventory values.”

SMU continues to hear from every corner of the country a desire by buyers not to build inventories – especially as steel prices meet or exceed the high point of the last cycle. The last up cycle occurred from early June to late September 2009 when the SMU Hot Roll averages rose from $380 per ton to $570 per ton (our range at the peak was $540-$600 per ton). The SMU current HR index is at $600 per ton….

Even those supplying the automotive industry are questioning how long it will last –“[we have] increased demand, although no one is sure for how long. Projections from the Big 3 are telling us 2010 is going to be a good year for us all but projections from our customers don't go out farther than a couple of weeks (although they are getting 50%+ more volume in many cases per release of stamped parts). Could ride this wave through 4 strong quarters or it could die out at anytime. No one is confident either way.”

The Cycle will Repeat Itself

“There is on thing they [domestic mills] never grasped,” one large service center corporate buyer told SMU this morning, “they allow the pricing cycle to repeat itself over and over.” We discussed pricing and this executive told us, “I don’t think anybody is convinced of anything these days [regarding higher prices].” He told us one of the issues they have with their customers is the lack of support by mills like U.S. Steel and ArcelorMittal who will make pricing changes but will not put anything in writing “our sales guys want those letters” he told us and explained how difficult it is to pass along a price increase without documentation from their suppliers.

He went on to tell us, “ArcelorMittal and U.S. Steel are letting Nucor and AK Steel be the price leader.”

It is SMU’s opinion that our readers be aware of price movements (transactions) of Nucor and AK Steel as well as the mini-mills (for HR especially Beta, Duferco Farrell, Gallatin & BlueScope) and for coated products the conversion mills (CSN, The Techs, Wheeling-Nisshin, Steelscape and Sharon Coatings) they will most likely be the first to adjust prices.

Scrap prices are reported to be moving mostly sideways for the month of February (exact levels have yet to be determined and appear will vary depending on the region of the country). Our dealers are telling us the tightest scrap product is Prime grades (such as #1 Busheling) while shredded is weak and HMS is mostly moving sideways. Without further increases in scrap will steel prices start to weaken?

With new steel melting capacity due up by mid to late March will the supply balance tip?

Will the mini-mills allow AMUSA, USS and Severstal to bring on capacity and attempt to grow market share?

Demand has improved and our survey shows 28% of our respondents expect their demand to grow by at least 10% over the next three months. Is the demand growth going to be enough to keep the newly restarted blast furnaces and mills busy?