When the Road Gets Rough, the Tough Get Hedging: StoneX

“It can only go up in a straight line for so long.… The story has changed a lot the last couple of weeks, the market has collapsed,” Johnson said. “And it’s not been a small turnaround.”

HRC Futures

Case in point: the CME Group’s June HRC futures contract was at approximately $1,425 per ton ($71.25 per cwt) two weeks ago. The June contract was trading at $1,226 per ton in afternoon trading on Thursday, Sept. 30 – indicating that futures market participants believe steel is set to see sharp drops like those in the seaborne iron ore market.

Iron ore prices have fallen from approximately $200 per ton over the summer to roughly $100 per ton more recently.

“If a price correction happens, maybe it will be $100-200 per ton, but it might be a lot more than that,” Johnson said, noting that the forward curve is “pricing in that we might be at the peak and could start falling.”

But players in the physical market, in contrast, might be worried about inflation and about not being able to get enough people or trucks to move the steel for which they are still seeing good demand.

“If the forward curve is $600 per ton ($30 per cwt) lower versus what the market is offering you today, then that might be attractive,” Johnson said.

One example of that: The CME Group’s October hot-rolled coil futures contract was at $1,900 per ton in afternoon trading on Thursday, or roughly in line with SMU’s spot price of $1,920 per ton. CME’s March HRC contract, in contrast, was at $1,310 per ton, or $610 per ton below current spot prices.

Futures and Import Arbitrage

Futures also offer good opportunities for traders and other buyers of foreign steel, who could in theory take advantage of any wide spreads – or arbitrage opportunities in trading lingo – between current import offers and futures prices.

“The amount of money that they could make is based on the spread differential between where they can buy physical steel today and then sell it into the futures market. If that spread is wide, they could make a lot of money. If it’s not, they most likely won’t – it’s a moving target” Johnson said.

Let’s say you were able to secure hot-rolled coil from abroad for $1,000 per ton to arrive in January. The CME’s January contract was approximately $1,500 per ton on Thursday afternoon. One could, in theory, make $500 per ton on such a hedge. And the Panamax vessels used to traverse the Panama Canal carry approximately 40,000-50,000 tons – representing a theoretical profit of $20 million to $25 million.

But opportunities of that magnitude rarely stay in the market for long. And current import offers for HRC for first-quarter arrival to U.S. ports are approximately $1,500-1,650 per ton – or above current futures prices for the first three months of 2022.

“There was a moment in time where the futures price was above the import price, but that might not have lasted long strictly because of arbitrage,” Johnson said.

Volatility

While import arbitrage opportunities might come and go, volatility in steel markets appears here to stay.

The market could fall $900-1,000 per ton and still be 99.9% higher than where prices have been historically. The peak of the last steel supercycle, in the summer of 2008, was $1,070 per ton – or $875 per ton below current spot prices. Recall, too, that spot hot-rolled coil prices a year ago were $605 per ton – or more than three times below current prices.

But volatility is not something that became a feature of the market following the Covid-19 pandemic. One could make the case that the current volatility had its origins in Section 232 tariffs and quotas and the shock of Trump-era trade policies and policy making.

As if tariffs on U.S. allies weren’t surprise enough, the former president at times adjusted U.S. tariffs on his twitter feed – as when he doubled tariffs on Turkish steel to 50% in August 2018.

The volatility then might seem modest compared to the wild swings in steel prices over the last year. Still, the national security tariffs and Trump’s twitter “opened a lot of doors to people considering financial risk management,” Johnson said.

The Scrap Scene

Scrap futures, in comparison, are comparatively steady.

The CME’s October contract for busheling was at $594 per gross ton in afternoon trading on Thursday. The contracts for the first quarter were only modestly lower. January and February were at $590 per gross ton and March was at $585 per gross ton. In other words, scrap prices are poised to remain higher than what finished steel prices were a little over a year ago, according to SMU’s interactive pricing tool.

“When there was a lot of vertical integration in the (EAF) industry, there was criticism that the mills were overpaying for scrap companies. But in retrospect, those might have been the deals of the century,” Johnson said.

The David J. Joseph Co. (DJJ), one of the largest scrap processors and brokers in the U.S., was acquired by Charlotte, N.C.-based Nucor for $1.44 billion in March 2008.

That move came after Steel Dynamics Inc. (SDI) bought OmniSource Corp., a major Midwest scrap processor, in 2007 for slightly more than $1 billion.

By Michael Cowden, Michael@SteelMarketUpdate.com

Editor’s note: If you’d like to prepare for potentially volatile times ahead, check out SMU’s Steel Hedging 101 workshop. It will be held on Nov. 2-3 with Spencer Johnson. You can sign up by clicking here.