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Raw Material Prices: Iron Ore, Pig Iron, Scrap, Coking Coal & Zinc

Issued at 2016-01-24



This article covers iron ore, pig iron, scrap, coking coal and zinc spot pricing. In this article, author Peter Wright reviews some of the key commodities and provides correlations that we believe our readers should be aware of and take into consideration when buying or selling steel. This data is normally reserved for our Premium level members but we decided to share it with our entire membership. This piece combines our own data analysis with recently published opinions that we find credible.

On December 28th Andrew Hecht wrote: The U.S. dollar is the pricing mechanism for most commodities. That is because the dollar is the reserve currency of the world. As such, there is a historical inverse relationship between the U.S. currency and raw material prices. The elevated dollar has weighed on commodity prices in 2015. Additionally, the prospects for higher U.S. interest rates have added additional bearish pressure on the prices of many raw material markets. The U.S. economy continues to grow at a moderate pace making the dollar attractive from an investment and a reserve currency basis.

This will support the greenback in 2016. Moreover, the U.S. central bank said that they expect 3-4 more interest rate hikes in 2016 as they are now in a cyclical tightening phase. The U.S. Federal Reserve promised all throughout 2015 that interest rates would begin to rise during the year. They finally delivered on that promise in December when the central bank hiked the Fed Funds rate for the first time in nine years by 25 basis points. While the rise was nominal and rates went up from zero, the move was significant. The U.S. economy is growing at a moderate pace. In Europe and China interest rates continue to drop. Therefore, on a relative basis, an interest rate rise in the U.S. is supportive of the dollar versus other currencies.

That is inherently bearish for commodity prices. Moreover, higher U.S. interest rates increase the cost of carry for inventories of commodities. As a higher dollar is historically bearish for commodity prices so are higher U.S. interest rates. These two factors added to bearish pressure on commodities in 2015. Commodity prices will eventually find a bottom. However, as we enter 2016, chances are we are in for more of the same and the bear market in commodity prices will enter year five. I expect a continuation of lower highs and lower lows in this asset class in 2016.

Iron Ore

The Platts IODEX of 62% Fe delivered North China fell below $40 in early December and reached $38.60 on the 11th. On January 11th it had recovered slightly to $39.01/dmt (figure 1).

The IODEX is down by 44.7 percent since the beginning of 2015 and by 69.3 percent since the beginning of 2014. Pessimism about the steel market and reduced cash flow are encouraging steelmakers to reduce iron ore inventories as much as possible. On January 10th Caiman Valores concluded that, “China's emergence as a global economic super power and the abrupt end to its catch-up growth phase has created a paradigm shift for the global economy and financial markets. It signifies the end of the greatest commodity boom of modern times and a fundamental shift in the growth drivers of the global economy, with the emerging markets growth model that had dominated global growth now seemingly broken. This means that investors need to become accustomed to significantly lower commodity prices that, with the exception of crude, now appear to be the new normal.”

There is a long term relationship between the prices of iron ore and scrap. Figure 2 shows the IODEX, and the price of Chicago shredded through January 11th.

The price of Chicago shredded remained unchanged in September, dropped $50 in October and another $20 in November, was unchanged in December and bounced back $30 in January. The correlation between scrap and ore since January 2006 has been 82.92 percent. In the period 2007 through 2009 the correlation was 91.82 percent but the relationship became de-coupled in 2010 and 2011 when the big three ore cartel began to eliminate long term contracts. There was a decoupling in the other direction in 2014 through September 2015.

With the October and November decline in scrap price the relationship came back exactly into line but the December decline in iron ore prices followed by the January scrap price increase has once again given the integrated producers an iron unit cost advantage. In the long term average, Chicago shredded has been 3.3 times as expensive as the IODEX with quite a wide spread in each direction. For four years through December 2013 scrap was advantageously priced on a historical basis compared to ore. Throughout 2014 scrap became increasingly uncompetitive and today the ratio is at 4.87 (Figure 3).

Pig Iron

The average price of pig iron from Brazil’s North and South ports was $172.5/metric ton on January 11th, unchanged since November 6th but down by $45 since October 9th. Through 2014 the price of pig iron held up better than the price of ore with a decline of 4.4 percent but in 2015 the price declined by a further 54.6 percent.

Scrap

There is a close non causal relationship between the price of scrap and the price of oil. Figure 4 shows the scrap/oil relationship through January 11th which is the latest data from the Energy Information Agency of the US government.

There have been reports in the press that oil is now below $30 but we have no confirmation of this figure. The scrap to oil price correlation is 0.9270 since January 2000 and 0.93743 in the 25 years since January 1990. We attribute the closeness of this relationship to the facts that both are global commodities and both are priced in dollars. Since the global oil market is so much larger than the global scrap market, scrap tends to “revert” to oil which has historically provided a rather prescient view of future scrap prices.

In other words if scrap gets out of line in either direction it tends to revert to the oil line which is a strong buy/hold signal. It was clear in December 2014 that if the historical pattern continued, scrap was headed for a fall and this has occurred throughout 2015 until October when the prices exactly aligned.

Since then scrap has again become high and the gap widened in January as scrap went up and oil went down. It is very unusual for these commodities to move in opposite directions, a close examination of Figure 4 shows that the last time it happened was in late 2009, after which scrap headed south in a reversion to the oil line. Figure 5 shows the relationship between shredded and #1 busheling both priced in Chicago.

Normally busheling has a premium over shredded but since last March that has evaporated to the extent that busheling in January is reported to be $10 lower than shredded. We assume this is a demand effect as the sheet market has declined dramatically in the last few months. In December Nucor announced their intention to temporarily furlough their DRI plant in Louisiana then reversed that decision in January. DRI has to be cost advantageous compared to pig iron out of Brazil and domestic busheling and that comparison has to include the higher furnace cost of melting it in an EAF.

Coking Coal

The price of coking coal FOB East Australian ports was over $300/metric ton for most of 2011 then declined abruptly in the 4th Q of that year to $222 on December 30th. The price bottomed on November 27th 2015 at $72.30 and has since edged up to $76.70 on January 15th (Figure 6).

Zinc

According to the International Zinc Association, the major use of zinc is for galvanizing, other significant uses include the alloying of brass and bronze and in zinc-based alloys used in the die-casting industry. Kitco publishes a daily spot price of zinc which we have transcribed to Figure 7.

Just as a point of reference we have included aluminum in the same graph. At the end of April 2015 the 30 day spot zinc price peaked at $1.0381/lb., then the price slid precipitously to $0.7322 on September 22nd. After a small upward blip in late October the price declined again to $0.6723 on January 21st.


Source: Steel Market Update



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