'99 Market Forecast—Bull or Bear? Place Your Bets

Are you bullish or bearish? 

For most individuals and industries—and certainly for those who buy, sell, broker, and consume scrap commodities—the answer most likely is: It depends.

In particular, it depends on myriad qualifiers and assumptions about the overall economic health of the United States and the world.

What, then, is the domestic scrap recycling industry thinking about business prospects for 1999 and what will be the key commercial challenges this year? Is it a recession? Or is it deflation? Industry consolidation? None of the above?

This year’s look into the future is based on a host of doubts about the state of the U.S. economy and, significantly, the assumed recovery of the major Asian and Latin American economies in 1999. “Caution” was a watchword expressed by scrap processors and consumers when discussing industrial production in the months ahead and how it could affect transacted prices on world commodity exchanges.

While there were a few bulls willing to express their optimism—primarily on equities—for 1999, commodity bears clearly held the majority.

Is the Financial Crisis Over?

 Among its many highlights, 1998 will probably be remembered by U.S. industry as the year in which it experienced the full impact of Asia’s fall into economic turmoil, which erupted in the summer of 1997.

Following the devaluation of the Thai baht in July 1997, Southeast Asia was beset with collapsing currencies and stock markets, not to mention a liquidity crisis followed by plunging domestic demand.

Japan, whose economy accounts for two-thirds of Asia’s economy and 15 percent of the world economy, fell into deeper recession. The financial turmoil was labeled the “Asian flu” and, like a flu, it was contagious.

At first, the currency crisis was ignored by the rest of the world, though most Western economies, recognizing their interdependence with Korea, Taiwan, Japan, and other Pacific Rim nations, fretted whether Asia’s problems would turn global. 

Looking back, those early concerns were warranted. In 1998, there was even greater financial havoc that ultimately infected the economies of Russia and Latin America. World commodity markets began talking about “deflation,” while the U.S. stock market was looking more vulnerable than ever as the summer of 1998 ended.

The International Monetary Fund (Washington, D.C.) was soon decreasing its 1998 predictions for global growth. Not since the early 1980s had so many countries plunged into recession so quickly. Only the United States and Western Europe escaped, but after 18 months of exposure to the Asian flu, the burning question became: Is the United States next? U.S. foreign trade was clearly suffering, but was that enough to have a major impact on the nation’s gross domestic product (GDP)? 

As it turned out, the second-quarter GDP expanded at a tepid 1.8 percent annual rate, the slowest quarterly growth rate in three years. But by early in the third quarter, GDP numbers turned upward again, fueled by consumer spending and inventory increases. 

Nevertheless, by early September, the Economist magazine reported that “for the first time since the early 1980s, global slump is a thinkable, even plausible, outcome.” The only thing standing between the world and an economic setback, it said, was the momentum of growth in the United States and Europe.

The Resilient U.S. Economy

 Buoyed by encouraging news on the health of the U.S. economy midway through the fourth quarter, coupled with reports that Asia was slowly getting its collective financial houses in order, the fear of a global economic collapse receded for the moment. Stock markets throughout Asia were again heading higher, aided in part by news that Japan planned to begin reviving its slumping economy through public works spending and income tax refunds. Brazil also seemed to be stabilizing, and there were no new Russian shocks to report.

In the final months of 1998, many analysts were beginning to think seriously in terms of global economic recovery in 1999, if not commodity recovery. In November, for example, a panel assembled by the National Association of Business Economists (Cleveland) said it expects the U.S. GDP to have grown 3.6 percent in 1998 and increase 2.1 percent in 1999—both down from the 1997 growth rate of 3.9 percent. Inflation, which the panel estimated to be 1.6 percent in 1998, is expected to rise to 2.2 percent in 1999. Most European economies, meanwhile, continue to predict GDP growth rates of 2.5 to 3 percent for 1999.

 Adding to the positive sentiment, the Federal Reserve Bank lowered short-term interest rates three times between Sept. 29 and Nov. 17, prompting the stock market to set a record at November’s end. It seemed that virtually all doubts about the U.S. economy and equities that chilled the New York Stock Exchange in early October had melted away.

Thus, equity bulls appeared to be charging ahead as 1998 wound down. But what about the commodity bears? Recyclers of ferrous, nonferrous, and nonmetallic scrap saw their respective prices and profit margins fall sharply throughout the year. For them, recovery was a distant prospect. Many were thinking in terms of survival.

Scrap industry mergers and acquisitions, a major source of news and speculation in 1996 and 1997, have all but faded from the scene as the consolidators hunker down to restore order to their balance sheets. Several highly leveraged consolidators have, in fact, adopted a siege mentality as they deal with conditions described by one leading scrap executive as the “worst in 30 years.”

It’s against this backdrop that scrap recyclers enter 1999. So, then, are you bullish or bearish?

Aluminum

 If you’re an optimist, the November 1998 Spector Report offered hopeful signs suggesting that the gloom and doom of October may have been the bottom for aluminum. For 1999, the publication forecasts Western World shipments of 20.3 million mt, 2 percent more than the 19.9 million mt expected in 1998, and U.S. shipments of 10.3 million mt, 3.5 percent more than 1998.

World stocks of aluminum—reported and unreported—remain a major area of disagreement among analysts and, thus, are critical to any price forecast. The Spector Report, for one, points to the declines in LME warehouses in 1998 and predicts further inventory reductions ahead.

Not all agree, of course. Billiton Metals Ltd. (London) is looking at a “modest” demand boost in the Western World but much higher production and little relief in terms of net imports. As such, there’s no fundamental reason why aluminum should move higher “in the short/medium term,” the firm says. Its 1999 forecast calls for a Western World statistical surplus of 500,000 mt and a price average of 62 cents a pound, 2 cents higher than its estimate for 1998.

Still others have lowered their expectations for aluminum based on the unsettling macroeconomic events of 1998. Morgan Stanley Dean Witter (New York City) trimmed its 1999 projection for the cash LME price from 70 cents a pound to 65 cents—still slightly higher than its projected 1998 LME average of 63 cents. CIBC Oppenheimer (New York City) also lowered its 1999 LME price forecast from 70 cents to 60 cents. The firm expects aluminum supply and demand to remain “fairly balanced” and for ingot to trade between 56 and 62 cents through the first half, with a rebound in demand to boost prices later in the year.

For aluminum recyclers, relatively lower prices ahead hint at thinning margins and a continuing struggle to maintain scrap flows, especially for those dependent on retail or over-the-scale business. UBC recovery, in particular, was a noteworthy casualty in 1998 as supplies dwindled due to sustained price weakness.

Most primary aluminum producers and recyclers, however, weren’t looking for a quick turnaround in terms of industry profitability, though they do see consumption improving by the second half of the year. Whether higher prices will follow remains uncertain.

Copper

 In virtually every 1999 copper supply-demand forecast, supply dominates the midterm outlook—along with conservative price projections. The mood among most copper officials was subdued in late 1998 as prices in New York and London hovered around lows last seen 12 years ago. In early December, LME copper stocks were at their highest level in 41/2 years.

Morgan Stanley Dean Witter forecasts Western World copper supply growing 4.4 percent in 1999, spurred by new capacity, but no drop in scrap availability as in 1998. Copper consumption, however, could grow much slower at 1.5 percent, resulting in a 400,000-mt increase in inventories, the firm projects. Using the Comex cash price as a reference, the company expects copper to average 75 cents a pound this year—lower than its 76-cent estimate for 1998. (For reference, 1997 Comex copper averaged $1.04.)

Others see even larger surpluses building. The Australian Bureau of Agricultural and Resource Economics (Canberra) pegs Western World copper production at 13.95 million mt this year against consumption of 13.20 million mt, leaving a statistical surplus of 750,000 mt. Still others see a potential 1 million-mt surplus, with average price predictions (LME three-month basis) ranging from a low of 69 cents to a high of 74 cents.

Not all are so pessimistic. After being bearish on the red metal for several years, Salomon Smith Barney (San Francisco) says it’s now neutral, forecasting a 75-cent price with a trading range from 70 to 90 cents.

Copper producer Asarco Inc. (New York City) remains the most optimistic, maintaining that analysts underestimate demand and overestimate supply, including the amounts of recoverable scrap. This error could be as high as 500,000 mt on the supply side, said Richard de J. Osborne, chairman and CEO, in November. This view, coupled with “improved economic activity in Asia,” could push copper to $1 a pound this year, he said, asserting, “We’ve seen the worst.”

Still, assuming that supply will likely overshadow demand this year, the size of the surplus will depend on how quickly prices fall in the interim and whether the principal consuming regions have a stronger-than-expected economic recovery. The deteriorating fundamental picture in 1998 has already prompted two major U.S. producers to trim production in the months ahead, but the question remains: Will others follow?

Iron and Steel

 “Crisis” was the word often used to describe the state of the domestic steel industry as 1998 ended and 1999 began. In general, demand for steel wasn’t the issue. The central problem was the severe price deterioration that has plagued the steel industry since the second quarter. The culprit? Primarily imports.

Steel producers have responded by cutting production and filing antidumping cases against hot-rolled carbon sheet from Japan, Russia, and Brazil. The filings could result in tariffs on some types of foreign steel in six to 12 months. And more trade cases are expected to come before the International Trade Commission in 1999.

Looking closer at domestic steel shipments, most analysts expect the final tally for 1998 to be off only a percent or two from the 105 million tons shipped in 1997, while raw steel production will likely have increased slightly. Imports, however, were expected to have increased more than a third, thereby capturing a larger share of the domestic market as well as adding to inventories held by users and service centers.

For this year, Morgan Stanley Dean Witter is projecting steel shipments of 102 million tons, with imports falling to about the 1997 level. Steel consumption, however, is expected to post a decline, according to others, due to slightly weaker demand prospects this year and anticipated inventory drawdowns.

According to the International Iron and Steel Institute (Brussels), world steel demand is forecast to recover to 695.3 million mt compared with 689.9 million mt estimated for 1998.

Not surprisingly, domestic scrap prices, which are normally extremely sensitive to economic fundamentals, plummeted in the second half of 1998, with benchmark prices falling nearly 50 percent between January and December. Thus, while admittedly pessimistic at the start of the new year, many believed that a bottom had finally been reached by late 1998. At the same time, several processors insisted that prices had limited upward potential, at least through the first quarter of the year. The consensus outlook calls for scrap price weakness, tighter scrap supplies, and a ready supply of scrap complements for many months to come.

Lead

 The U.S. lead industry, dominated by the lead-acid battery industry for starting, lighting, and ignition purposes, had a positive 1998, with automotive replacement shipments approaching the 1994 record of 80.1 million units. 

To meet this demand, primary refiners expected to surpass their 1997 output, while secondary smelters struggled to keep pace. Low lead prices, a feature throughout the year, and relatively low supplies of scrapped batteries in the first half virtually eliminated any profit for smelters purchasing scrap batteries on the open market.

Despite positive overall lead consumption in the United States, Western World fundamentals are less than encouraging for 1999. Forecasts at ISRI’s lead roundtable in September pointed to a refined metal surplus of 30,000 mt for 1998, growing to 50,000 mt in 1999. On the other hand, the International Lead and Zinc Study Group (London) is looking at lower world refined production and a slight increase in consumption. The result, the group believes, will be a close balance between supply and demand in the Western World.

Price predictions are rather conservative, with Barclays Capital (London) asserting that any price recovery in 1999 “is likely to be short-lived” because, it notes, most analysts are forecasting a lead surplus between 50,000 and 100,000 mt. Its own forecast calls for an LME three-month average of 22 cents a pound this year. Other bank and brokerage firms put cash LME lead ranging from a low of 21 cents to a high of 24 cents—similar to lead’s trading range throughout 1998.

Domestic smelters, worried about scrap availability in 1998, are less anxious about scrap supply in 1999. Whole battery prices, some maintain, won’t be inclined to rise above current levels given the expected replacement demand and the relatively low LME prices being forecast. Other lead executives were hoping that 1999 would be the year that domestic lead pricing finds an acceptable alternative to the LME, which they insist doesn’t reflect the realities of the domestic market.

Nickel and Stainless Steel

 One global industry that arguably has suffered more than most in the past 12 months has been stainless steel, specifically the nickel-containing flat-rolled and long products. One main reason is that Asia, which accounts for around 35 percent of world nickel consumption and which commonly had annual stainless consumption growth rates over 15 percent, slipped into negative territory.

As demand dwindled, producers around the globe saw profits disappear in 1998. They also saw the healthy state of the U.S. economy, which made it a magnet for their products. Imports soared and domestic producers initiated antidumping charges against eight countries. According to Morgan Stanley Dean Witter, an average price for cold-rolled grade 304 in the    United States and Europe dropped from around $2,100 a mt at the end of 1997 to less than $1,600 a mt as 1998 closed.

The near-term outlook isn’t much better. Charles River Associates Inc. (Boston) expects slower global stainless growth ahead and “significant” melting and finishing capacity “for the next seven years.” While stainless steel demand could recover “after about 18 months of cyclical downturn,” overall consumption in 1999 will decrease, the firm says.

The fortunes of the nickel industry are inexorably tied to the health of stainless steel, and that metal has suffered due to falling demand exacerbated by new production and a reluctance by producers to cut back. Heinz Pariser Alloy Metals & Steel Market Research (Xanten, Germany) says that although nickel demand will “probably be fairly good” in 1999, nickel will face a Western World surplus of 20,000 mt based on 1.01 million mt of supply and 990,000 mt of demand. Nickel producer Falconbridge Ltd. (Toronto) estimates the 1999 nickel surplus at 18,000 mt. 

Nickel prices, notes Brandeis (Brokers) Ltd. (London), are thus expected to range from $2 to $2.50 a pound in the next 12 months, reflecting “poor demand” from the stainless steel sector as well as the startup of “significant volumes of low-cost production in Australia.” Brook Hunt (London) forecast a $2.34 LME nickel price at ISRI’s nickel/stainless steel/specialty metals roundtable in October, while also calling for nickel surpluses “for the next few years.” These projections don’t bode well for domestic suppliers of 18/8 stainless steel scrap.

Paper

 For the domestic paper and paperboard industries, 1998 was characterized by little or no growth compared with recent years. Nevertheless, data from the American Forest & Paper Association (AFPA) (Washington, D.C.) and the Bureau of the Census showed that scrap paper consumption in 1998 was running slightly ahead of 1997. According to AFPA, scrap paper consumption last year was approximately 44.7 million tons, higher than 1997 but well short of the 7- to 8-percent growth rates posted in 1996 and 1997. Nevertheless, recovered paper continued to increase its market share against virgin materials despite the apparent slowdown in production. Scrap paper exports were also expected to show an increase in 1998 compared with 1997.

Processors of scrap paper, however, could find little solace in the demand, consumption, and export figures as prices for all secondary grades trended lower throughout the year and mills’ inventories of recovered fiber increased in the final months. As 1998 ended, average scrap prices were visiting lows last seen in the third quarter of 1996. Processors attributed the lower selling prices to the cumulative effects of a sluggish domestic market for paper and paperboard compounded by relatively soft export markets and weak demand for wood pulp. Mill downtimes, they said, added to the doldrums.

According to a report by Resource Information Systems (Bedford, Mass.), slow economic growth in the United States and Asia will hold down paper and paperboard production in 1999, while market conditions for recovered paper will remain flat despite “occasional restocking by domestic and overseas producers.” The firm sees minor price increases for market pulp early this year and slightly higher prices for bulk grades such as OCC and ONP later in the year. Another study by Jaakko Poyry Consulting Oy (Helsinki) suggests that average OCC prices in 1999 will be below their long-term trend.

In addition to hoped-for higher prices in 1999, processors expect this year to be marked by reductions in North American papermaking capacity—mostly through mergers and acquisitions—while others speculate that some paperboard mills will close altogether this year.

Plastics

 After a difficult 1998, in which virgin and scrap plastic prices slipped lower as supply overwhelmed the otherwise positive demand for most commodity-grade resins, analysts see little relief in 1999. PP appears especially troubled, with worldwide oversupply dominating its outlook. Downward price pressure is expected to be a feature in 1999 despite other projections that point to higher domestic consumption.

PET is also struggling due to an oversupply of polyester resin, fiber, yarn, and fabric in North America and the world. Again, demand isn’t the issue, with consumption expected to be close to the 15-to- 18-percent annual growth rates of the past few years. New production capacity, however, is expected to keep a tight lid on PS prices in 1999. Analysts believe that margins for resin producers are likely to remain tight until 2002 or 2003.

On a more positive note, the market for PVC is expected to benefit from anticipated steady demand from the industrial sector this year, with prices forecast to rebound from the 11-year lows posted in 1998.

Lower prices for virgin resins have negatively affected recyclers of plastic containers, who have had to endure lower prices for their recycled resin due to the ready supply of competing virgin and so-called off-spec material. Lower offshore demand for scrap compounded market difficulties last year.

In 1999, analysts are hoping that resin production cuts, coupled with winter weather-related factors, could reduce the supply of feedstocks and firm prices for scrap. Still, the consensus is that the overall outlook for recyclers of postconsumer plastic scrap isn’t particularly encouraging.

Zinc

 In contrast to other metals traded on the LME, the Western World zinc market had “generally constructive” fundamentals in 1998, say industry officials, with several predicting that the market would post a statistical deficit.

Nevertheless, few were willing to wager that zinc prices would soon take off, as concerns over the financial crises in Asia overtook virtually all other market-related issues.

LME three-month zinc prices, in fact, drifted lower last year, testing new lows in the final quarter. Most domestic producers and consumers maintained, however, that in the United States, at least, zinc was “undervalued.”

Will it remain undervalued in 1999? At ISRI’s zinc roundtable in September, Angus MacMillan, research manager for Billiton Metals (London), forecast increases in both refined zinc production and net East/West trade, specifically in the form of Chinese metal, resulting in a market surplus of 25,000 mt. 

He further believes that a “modest upturn” in Western World demand is in the cards despite a slowing U.S. market, while Europe will continue to grow. He also said LME cash zinc could average 49 cents this year, compared with a 1998 estimate of 47 cents. Rudolf Wolff & Co. Ltd. (London) predicts that world zinc will see a surplus of 108,000 mt following two years of deficit.

The International Lead and Zinc Study Group differs in that its supply-demand balance comes up with a deficit due to what it believes will be a significant decrease in metal moving from Eastern Europe to the West. Chinese output, meanwhile, will be “limited” following the closure of outdated smelters, the group says. Clearly, Chinese production and subsequent exports loom large in any zinc price forecast.

Other forecasts for LME cash prices in 1999 range from a low of $992 a mt from Deutsche Morgan Grenfel (London) to a high of $1,090 by the Economist Intelligence Unit (London). Meanwhile, domestic slab zinc consumers of SHG and CGG zinc noted that the premiums negotiated for 1999 assumed that slab zinc supply would have little or no difficulty meeting the demands of both the galvanizing sector and zinc alloyers. •