The following is daily commentary for the Week of July 17, 2023. You can scroll down to see portfolio positioning throughout the week along with various performance metrics. This post gets updated every morning prior to market opening so be sure to check back for daily updates.
Monday 7/17/2023
Steel & Met Coal Markets
Throughout Q1, the Chinese market remained resilient due to the relaxation of Zero-Covid as well as favorable macroeconomic policies. As the year progressed however, expectations of an economic revival for 2023 have disappointed and Chinese domestic steel demand has continued to be weak. Although Chinese steel prices experienced a recent price bump driven by optimism surrounding potential economic stimulus, the overall state of the domestic market is bleak. Hopes for comprehensive government intervention to stimulate the economy have so far been ultimately unfulfilled. This has lead to a recent negative shift in sentiment since so far, the support measures have been limited to interest rate cuts. The PBOC cut several benchmark lending rates by 10 bps, including Loan Prime Rates which determine the cost of borrowing for households and businesses. But in general, the market has been disappointed that broader measures targeting real estate or infrastructure have not materialized.
We saw a temporary boost to both steel futures and spot prices at the beginning of July due to production cuts in Tangshan, which is a key steel hub, but unless there’s a substantial reduction in steel production or a substantial increase in demand from end-users (primarily in the construction sector), this upward trend will most likely be short-lived. The Chinese market has shown a stronger performance than warranted in 1H 2023 on the back of weak domestic steel demand and a heavy reliance on exports. I fear that we could see a repeat of history if stimulus measures fail to materialize, resulting in further downward pressure on both steel, iron ore, and met coal pricing.
High steel prices and expectations in Europe and the US for a Chinese recovery led steel producers in those regions to increase output. For example, the idled blast furnace capacity in Europe had mostly been brought back online by the end of June. With demand weak however, and with stiff competition from Asian exports, that capacity is now at risk of being reduced again.
The outlook for European demand is not constructive given projected economic growth, sticky inflation and restrictive monetary policies. Germany, the so-called “factory of Europe,” recently entered a technical recession, and Christine Lagarde commented that the ECB was “not even thinking about pausing” the rate increases due to fears of a wage/price spiral. These policies will continue to weigh on economic output, and raw material demand.
In the US, hot-rolled coil (HRC) markets continue to decline. Steelmakers tried to establish a price floor at $900/t by announcing price increases in mid-June. But so far it seems these hikes have failed to gain any traction in the market:
Met Coal
In terms of metallurgical coal specifically, supply issues remain the primary driver. The general market perception of poor demand and overstocked inventories along with prices that are holding up remarkably well has confused many market watchers. I’ve attempted to explain this with my “$250/mt is the new $150/mt” thesis. Given this thesis, if Australian PLV is below $250/mt we should characterize the fundamental backdrop as poor. PLV is currently trading at $231/mt and has been unchanged for about a week. We’re therefore in a poor pricing environment, despite the seemingly high prices compared to years past.
Most analysts have a much lower long-term met price forecast compared to my own. Those forecasts are based on global costs curves. My retort to those forecasts is that met coal prices are currently acting as if they’re in a structurally undersupplied market. Structurally undersupplied markets do not function based off of cost curves. They react more strongly to the dynamics of the demand curve rather than the supply curve. Moreover, the cost curve has steepened sharply in the last two years, and many are simply guessing when they analyze Mongolian, Russian, and most importantly Chinese met coal supply costs.
My personal view is that 1) Chinese reserves of premium HCC are dwindling fast and 2) a significant portion of the semi-soft Chinese supply has been utilized in the thermal market, due to NDRC quotas.
In a nutshell, that’s how I view the met market. As I mentioned briefly already, supply has been the primary driver. Rebounding supply from Australian miners, combined with strong incremental supply from Mongolia and China, have kept a lid on met coal prices by somewhat solving the supply shortages. Otherwise we’d be at $250/mt or even higher. I’ve somehow gotten this far without mentioning India, but incremental Indian demand has already begun offsetting structural weakness in China. This will become a primary feature for met markets moving forward.
Summary