January/February 1998
Will the U.S. economy continue its winning streak? Will Europe’s economic recovery gain speed? And will Asia get over its financial flu? The uncertainty surrounding these questions is tempering optimism for the new year.
By Robert J. Garino
Robert J. Garino is director of Commodities for ISRI.
Back in September 1996, Donald Straszheim, then chief economist for Merrill Lynch & Co. (New York City), maintained that despite an apparent second-half 1996 economic slowdown, “nearly everything about the U.S. economy appears almost perfect”—moderate growth, low inflation, ongoing job creation. Looking toward 1997, he asked: “What could possibly go wrong?”
Many others in business, government, and academe were asking the same confident question—and for good reason. U.S. macroeconomic growth, as measured by the gross domestic product (GDP), hadn’t seen a negative quarter-on-quarter growth rate since 1991. Assuming that the last recession “officially” ended at the close of first-quarter 1991, most economists believed that the current expansion would be in its 81st month as 1997 ended.
And, as expected, the U.S. economy continued to post impressive growth numbers last year: First-half 1997 GDP growth, for instance, was around 4 percent on an annual basis, following a surging 4.9-percent pace in the first quarter but a more subdued 3.3-percent second quarter.
The second-quarter slowdown was attributed to lower consumer spending and shrinking exports due to the strong U.S. dollar. The stock market, meanwhile, trended higher as investors assumed this slower growth would keep the Federal Reserve Board from increasing interest rates to ward off potential inflationary pressures. (FYI—The Fed last increased interest rates in March 1997.) Early estimates expected third-quarter GDP growth of 3.3 percent.
For perspective, the U.S. economy has enjoyed only two longer expansions since World War II—the 106-month expansion from February 1961 to December 1969 and the 92-month expansion from November 1982 to July 1990. “Americans are fat and happy,” remarked economist Paul Getman at a Conference Board seminar in October.
Are we in an everlasting economic boom? Some think so, maintaining that the United States has developed a “Goldilocks economy”—that is, one that’s not too hot, not too cold, but just right—or a “new economy.” This latter phrase means, in short, that the United States has transformed its economic foundations by embracing new technology, corporate restructuring and downsizing (including mergers and acquisitions), and intense global competition, all of which have created unprecedented prosperity without inflation. Proponents of this paradigm shift contend that future growth is virtually assured.
The Global Economic Domino Theory
Global prosperity theorists received a rude awakening this past summer, however, amidst reports that Thailand would devalue its currency following years of virtually unrestrained and largely unregulated growth. Unfortunately, the “Thai sickness” spread in the ensuing months, affecting the currencies of Malaysia, the Philippines, Taiwan, South Korea, and Indonesia. Thus, after nearly a decade of impressive growth, the oft-cited “Asian miracle” led by Japan threatened to turn into a global economic meltdown.
As a result, the stock market selling that first appeared in Southeast Asia soon spread to Europe, Latin America, and the United States. The closely watched Hong Kong stock market lost nearly a quarter of its value in less than a week in October as Asian selling literally took on a life of its own. The U.S. stock market, as measured by the Dow Jones industrial average, plunged 554 points Oct. 27. This raised the question: Would the 1997 financial crises in Asia be the catalyst for economic disaster here in 1998?
World leaders huddled in Vancouver in November to map out a strategy to assure all that governments and international lending institutions would take an active role in restoring financial order, discipline, and confidence. While many are more cautious today when talking about a “new economy,” there’s still a sense of optimism for continued long-term growth with low inflation in the United States and around the globe. Hence, the economic problems in Southeast Asia, which will likely continue to make headlines for many months to come, won’t lead to a full-blown recession here, say financial experts.
Supporting this opinion is the fact that trade with Asia represents less than 10 percent of the $7.5-trillion U.S. economy, and it’s worth noting that some Asian countries—namely, Taiwan, Singapore, and China—were not in crisis last year. The U.S. overall trade deficit will suffer somewhat, but the currency problems in Asia, it was reasoned, should help hold down inflation in 1998. Others, however, believe that trade is but one casualty of what they contend is a precarious financial system that still threatens major financial institutions in Japan, Korea, Hong Kong, and the United States.
More Growth, Please
Despite what happened in Asia last year, the prevailing view is that U.S. economic growth won’t be significantly affected and, thus, GDP growth should remain positive in 1998.
In November, Curt Hunter, senior vice president and director of research for the Federal Reserve Bank of Chicago, predicted that the U.S GDP would expand at a 23/4-percent annual growth rate between the fourth quarter of 1997 and the fourth quarter of 1998. Inflationary pressures can’t be ignored, however, due to growing wage pressures caused by relatively low unemployment, he said.
Europe, too, is expected to grow. The 15-nation European Union predicted in October that its economy would, in fact, grow faster than the U.S. economy in 1998. “The economic recovery in Europe is confirmed,” noted Yves-Thibault de Silguy, the European Union’s finance chief.
How the events in Asia will affect world primary metal and scrap consumption has yet to be seen. Analysts point out, however, that Asian consumption of copper and other base metals could reasonably be expected to fall as infrastructure and construction projects are put on hold or canceled altogether.
The Scrap Angle
Do the domestic scrap processing and consuming industries share this larger view of the U.S. and world economies? And what about 1998?
Not surprisingly, as 1997 ended, many scrap processors and consumers were still digesting and analyzing the events that shook Asia.
Yet economic news wasn’t the only issue on their minds. Many also expressed concern about the massive consolidation trend underway in the scrap industry. They wondered how it could affect their future market access and profitability. For them, last year meant the beginning of a new challenge to existing business practices as well as a whole new look to the scrap processing and consuming industries.
According to Paul Higbee, managing director of BT Alex. Brown Inc. (New York City), some 10 million tons of scrap processing capacity was acquired last year. Since 1996, he maintains, 25 percent of the domestic industry has been consolidated.
ISRI President Jim Fisher, president and COO of Fisher Steel and Supply Co. (Muskegon, Mich.), views 1997 as “a turning point” for the scrap industry with respect to industry consolidation, contending that last year’s accelerated pace will continue through 1998.
Thus, with mergers, acquisitions, international currency issues, and domestic and world commodity supply-demand fundamentals to contend with, scrap processors and consumers say they’re entering 1998 with caution that will dictate both their buying and selling decisions through the year.
Notably, recession and inflation aren’t their overriding worries. Rather, deflation and world economic uncertainty have created a climate of heightened business conservatism and, with it, only modest growth and profit expectations, especially for the first half of the year. A minority of executives is even more bearish, asserting that a traditionally slower second-half 1998, coupled with a low-growth first-half scenario, could be enough to push the U.S. economy into “growth recession” later in the year.
Given these domestic and international dynamics, 1998 will certainly be an intriguing year to watch. Here’s a commodity-by-commodity roundup of what the scrap processing and consuming industries are expecting in the new year.
Aluminum
Aluminum can look forward to a year generally described as “probably steady,” with brighter prospects forecast in 1999 and 2000. Significantly, the principal caveat isn’t whether domestic demand will materialize, but whether world supply will overtake anticipated positive consumption. Price expectations, however, are generally conservative, owing more to a deflationary psychology that has gripped most commodities rather than worries over consumption.
Underpinning this view, it’s worth remembering that approximately 925,000 to 950,000 mt of primary capacity was shuttered following the 1994 memorandum of understanding, an agreement among producing nations designed to cut world output 10 percent and reduce then-bulging inventories. Though the agreement expired in early 1996, an estimated 600,000 mt of capacity remains idle.
The result is that by virtually every measure, this year’s world aluminum supply-demand balance comes up on the short side. Even with downward demand revisions due to expected Asian weakness in 1998, Alcan Aluminium Ltd. (Montreal) is predicting a worldwide supply deficit of 200,000 mt this year.
A similar view was put forward by Marubeni Corp., a leading Japanese trading company. In a report released in October, the firm projected that the 1998 Western World supply of primary aluminum will reach 18.5 million mt—up 2.5 percent over 1997—with consumption expected to hit 18.7 million tons. To balance this supply deficit, refined stocks will have to be drawn down 200,000 mt, according to Marubeni.
While some have lowered their earlier price forecasts, others see higher prices ahead, though they note that aluminum won’t get too far ahead of itself. With LME cash expected to end 1997 with an average in the low-70s-cent-per-pound range, an 80-cents-per-pound average for 1998 is viewed as optimistic despite the projected supply deficit. If this proves correct, domestic premiums for prime metal should ease slightly from first-half numbers.
While the scrap market will reap the benefits of any overall market price rise, it faces competition, some believe, from a ready supply of Russian-origin metal. For secondary smelters, the year could also bring increased volatility, tighter margins, and capacity consolidations, says James Southwood, president of Commodity Metals Management (Pittsburgh).
Copper
After years of what most believed to be fundamental tightness caused by strong global demand and exacerbated by production delays, most buyers and sellers now see the red metal moving inexorably toward a world surplus. Stocks of refined copper, as measured by LME and Comex inventories, increased throughout 1997, swelling more than 250,000 mt in the second half of the year alone.
Consequently, copper prices have been in decline since summer, averaging less than $1 per pound on an LME three-month basis since September.
The International Wrought Copper Council (London) predicted that world copper production would total 13.30 million mt last year, increasing 6.7 percent this year to 14.19 million mt. Western World consumption, meanwhile, was placed at 12.87 million mt for 1997 and 13.34 million mt this year. The council noted, however, that production numbers tend to be overstated while consumption figures tend to be understated. Nevertheless, world refined copper supply is expected to overtake demand this year and beyond.
Others, such as the International Copper Study Group (Lisbon), contend that copper was in surplus as last year ended. In November, the group pegged the oversupply at 200,000 mt through the first eight months of 1997. As for 1998, Rudolf Wolff & Co. Ltd. (London), Brandeis (Brokers) Ltd. (London), HBC James Capel (New York City), and Morgan Stanley and Co. Inc. (New York City) all see copper surpluses developing, with their projections ranging from a low of 250,000 mt to a high of 400,000 mt.
Not surprisingly, price forecasts were pared down as last year progressed. The tone at year’s end was decidedly bearish and unsettled, especially in light of the Asian financial crises. “It’ll be a tough year,” opined Robert Stein, manager of nonferrous for Louis Padnos Iron & Metal Co. (Holland, Mich.). He, too, foresees a market in surplus, as well as lower domestic demand and little upward price pressure. This, he maintains, will keep a lid on domestic scrap supplies next year.
Given the expected additions to supply and uncertain demand picture, many copper forecasters expect prices below the $1-per-pound mark this year, with additional downward pressure in 1999. There are a few optimists in the bunch, however, such as Chilean producers and Asarco Inc. (New York City), who cite strong demand both domestically and abroad, especially in China.
Iron and Steel
Global steel demand continues to astound, but prices for finished steel confound. According to Lenhard Holschuh, secretary general of the International Iron and Steel Institute (Brussels), world steel consumption should end 1997 at 695 million mt—the fifth straight year of growth at an average annual rate of 2.7 percent—with 1998 consumption projected to climb to 700 million mt.
Looking at the important Asian market, which accounts for 45 percent of world steel consumption, Holschuh held that even with the economic and financial problems in Southeast Asia, growth in Northeast Asia, Korea, Taiwan, and China would offset declines elsewhere in the region.
Domestic steel consumption also continued its roll, touching a 25-year high in 1997. Domestic steel producers continued to run at almost full capacity last year, with raw steel production expected to easily exceed the 104.4 million net tons produced in 1996. This higher production virtually assured positive demand for raw materials such as iron ore, pig iron, scrap, and DRI.
Nevertheless, domestic steel producers were clearly discouraged by weakening steel prices, especially hot-rolled, in the second half of last year. Softness was attributed to inventory destocking and what Salomon Brothers (Chicago) cited as a “weaker-than-expected auto build in August.” Commercial Metals Co. (Dallas), for one, noted that for fiscal 1997, average selling prices at its four minimills decreased around 2 percent while overall shipments increased 11 percent.
The 1998 outlook for steel producers and scrap suppliers contains both opportunities and challenges. On the plus side is expected growth in steel production, principally in the form of scrap-fed electric-arc-furnace output. This higher production will provide a relatively firm floor price for scrap, while scrap complements such as DRI will create a ceiling.
Scrap quality issues, however, will continue to be a dominant theme for ferrous scrap processors, noted ReMA President Jim Fisher. Though he sees bright prospects for the steel industry in 1998, processors can’t become complacent in this highly competitive arena, he advised.
Conversations with scrap processors, brokers, and producers seem to indicate that overall scrap availability won’t be as important an issue this year as steel mill profitability. An oversupply of finished steel, domestically and globally, is expected to be a potential stumbling block for all steel industry participants in 1998.
Lead
Following three years in which Western World demand exceeded supply, world fundamentals—and, hence, market sentiment—changed markedly as LME prices trended lower throughout 1997. By early December, LME lead was trading at levels that hadn’t been seen since February 1995. One saving grace was that LME inventories didn’t significantly increase last year, which kept prices from eroding further, analysts contend.
The domestic market wasn’t spared despite generally positive demand reported by most primary producers and secondary lead smelters. Premiums, which producers hoped would firm in the fourth quarter, were instead lowered in December. While replacement battery shipments for early 1998 are expected to reflect weather-induced demand, domestic scrap supplies aren’t predicted to ease up from the relative tightness experienced in second-half 1997. Price and margin expectations, however, aren’t viewed as encouraging.
Most analysts agree that, for the time being at least, there’s simply too much lead relative to world demand. Tom Schnull, manager-lead department for Noranda Mining and Exploration Inc. (Toronto), forecasts that along with expected new mine output this year and higher treatment charges, underutilized C.I.S. smelters may be called on to treat concentrates in 1998. The net result, he says, would be a Western World surplus of refined metal.
The International Lead and Zinc Study Group (London) concurs, projecting a global lead surplus of 50,000 mt this year. Brook Hunt (London) sees a slightly lower number. Following a modest 2,000-mt deficit expected for 1997, the market could see a 35,000-mt surplus this year and LME prices as low as 22 cents per pound “as the business cycle brings lower economic growth in the early years of the next century,” the group says.
Even more bearish is Robert Lesemann, a consultant with Resource Strategies Inc. (Exton, Pa.), who predicted in November that due to a potential 100,000 mt of new mine capacity due on-stream, lead prices could dip below “20 cents per pound” this year.
Nickel and Stainless Steel
As important as China is to the fortunes of copper and zinc, Russia is to the nickel and stainless steel markets.
Throughout 1997, Russia exported more refined nickel and nickel-bearing scrap than expected. In November, for example, Brandeis (Brokers) Ltd. noted that Russia’s primary nickel exports to the West through the first eight months were 37 percent ahead of comparable 1996 numbers. According to Macquarie Equities Ltd. (London), Russia’s nickel exports to the West would total 200,000 mt for all of 1997, an increase of 40,000 mt compared with 1996. Its scrap exports, meanwhile, would hit around 60,000 mt (nickel content) compared with 53,000 mt in 1996, Brandeis said.
Adding to overall supply concerns, others reported relatively high European stainless steel inventories and slower Asian demand coupled with overcapacity, all of which created a bearish climate for primary nickel as last year ended. LME nickel prices trended lower, recording consecutive lower monthly averages from May onward. By November, LME cash was testing a low for the year. Domestic stainless steel producers also saw their prices weaken in the face of lower-priced imports, overtaking what Bear Stearns (New York City) reported as “continued strong underlying demand growth for stainless steel.”
In sum, the Western World nickel supply-demand outlook for 1998 has appeared to shift from deficit to surplus, though Inco Ltd. (Toronto)—the world’s largest nickel producer—holds that nickel will record a deficit between 10,000 and 20,000 mt this year. Other forecasts by consultants and other producers, however, are calling for a nickel surplus of a similar amount at worst or a balanced market at best for 1998. Brandeis (Brokers), for example, forecasts a 10,000-mt surplus this year.
Nickel price expectations have subsequently grown more conservative, with LME numbers forecast in the low-$3-per-pound range as an average this year and declining further in 1999. Brandeis, for one, expects nickel prices to average $3.10 per pound. As for domestic stainless mills, Bear Stearns forecasts a modest 5-to-7-percent increase in 304 stainless prices this year compared with the 1997 average.
On the scrap side, processors believe mills won’t be aggressive buyers of 18/8 scrap this year, despite positive forecasts for stainless shipments, which are projected to reach 2.27 million mt, or 8 percent above 1997, according to Thomas Abrams, vice president of Credit Suisse-First Boston Corp. (New York City). Even so, processors and brokers believe that scrap supplies will be more than enough to feed existing domestic mills, as well as traditionally “melt-short” European producers.
Paper and Plastics
The pulp and paper industry continues its boom-and-bust pattern as witnessed in the past several years. Similarly, paper recyclers have also seen some of the best and worst of times since 1995.
Paper executives marked 1994 as the start of the last up-cycle for their industry, with momentum building in 1995 as pulp prices on the world market hit a record high of nearly $1,000 per mt for northern bleached softwood kraft. The price of newsprint soared to $750 per ton as well. By the fourth quarter, however, a down-cycle appeared to be in the cards for 1996. And it was, with supplies of finished newsprint to scrap paper pulp mounting and prices falling dramatically.
Despite efforts by paper producers to reduce inventories, pulp and paper price increases were held in check last year. Pulp prices moved tentatively higher in the second half, with some believing that a price of $650 per mt was possible by year’s end. As of November, however, pulp was fetching $610 and newsprint $570.
Most paper recyclers, meanwhile, also had little to cheer about. OCC prices were expected to end the year on a down note. In contrast, pulp substitutes and some office grades were said to be holding firm in most U.S. regions. Processors also noted softness in overseas demand, primarily from Pacific Rim mills, owing to currency devaluation in key consuming countries.
Nevertheless, the 1998 outlook appears brighter for paper producers and recyclers, according to paper industry analysts. Smith Barney (New York City), for example, sees a “general paper-pricing upcycle leading to higher earnings in 1998.”
On the recycling side, Thomas F. Bowers Jr., president of Schirmer Paper Corp. (Boston) and ISRI’s Paper Stock Industries Chapter, expects 1998 to be a “slow-growth” year characterized by higher pulp consumption and “gradual” finished product price increases for everything from packaging to tissue. Scrap paper prices will move up accordingly, aided by an expected recovery in export demand, he says, stating, “look for all grades to move forward next year.”
Plastics. The plastic industry also faced a difficult 1997, yet unlike the paper industry’s promising new-year prospects, plastics could continue to see difficult times this year.
In 1997, resin producers found most markets resistant to attempts to raise prices due to ongoing inventory reductions traced back to 1996 when prices were on the upswing. With the exception of virgin PET, most plastic producers saw margins erode despite relatively healthy demand.
This year’s outlook continues to look cloudy largely due to what some insist is a fundamental oversupply of ethylene on the world market. This, many believe, will set a dour tone for both plastic producers and recyclers alike.
Zinc
LME price volatility punctuated the 1997 zinc market, with cash and three-month quotes briefly visiting seven-year highs. Although Western World zinc demand was indeed positive, other factors were also at work that unsettled buyers and squeezed sellers in the summer, reportedly forcing artificially high and unsustainable prices. But by the fourth quarter, some were saying that the market not only corrected itself, but was overreacting on the downside. November LME prices, for example, were similar to what they were in February. What exactly were the market fundamentals saying?
In trying to match supply with demand, China remains the wild card, or supply balancing item, in any equation and, thus, any price forecast. Early 1997 forecasts reckoned that the Western World balance would fall short 200,000 to 300,000 mt and that this statistical shortfall would place demands on stocks of slab zinc. Price prospects, therefore, were bullish.
As it turned out, China’s exports of zinc and zinc alloy far exceeded most predictions. And in response to the summer squeeze, metal flowed into the highly visible LME warehouses. Higher LME inventories, coupled with weaker Asian demand, more than offset higher domestic consumption. As a result, prices and premiums weakened in the second half of the year.
As for zinc’s fate in 1998, opinions are mixed as to whether the metal will be in surplus or deficit. The International Lead and Zinc Study Group is in the surplus camp. In an October report, the group said that if exports from Asian countries—China, in particular—reach expected levels, Western World supply would likely exceed demand “by a small amount”—about 20,000 mt—in 1998, which would mark zinc’s first surplus since 1994.
Most independent analysts, in contrast, didn’t see a zinc surplus emerging this year, though many conceded that the level of Chinese exports rather than Western World demand for slab zinc would ultimately dictate transacted prices in 1998. While most price forecasts were in the 60s-cent-per-pound range, Billiton Metals (London) expects zinc to peak at 63 cents but average 59 cents for the year. On the more optimistic side, Credit Lyonnais Rouse Ltd. (London) sees ongoing supply deficits and, hence, zinc prices beyond 70 cents per pound in 1998. •
Will the U.S. economy continue its winning streak? Will Europe’s economic recovery gain speed? And will Asia get over its financial flu? The uncertainty surrounding these questions is tempering optimism for the new year.