2009 Market Forecast: The Shape of Things to Come

January/Febraury 2009

By Bob Garino

Last year began with the United States facing some economic headwinds, with storm warnings on the horizon. At the time, it was clear that a financial crisis was accelerating, as investment losses mounted and investors sold off stocks. The U.S. government responded by rushing through the first of many stimulus packages, while the Federal Reserve boosted liquidity by lowering interest rates. Both actions were designed to contain what was thought to be a $300 billion problem tied to the arcane domestic subprime mortgage situation. Only a few realized, however, that the problem had the potential to stall domestic and global expansion, dragging down commodities in general and the scrap industry in particular.

In hindsight, the gathering financial storm could have served as an early warning for the recycling industry and the investment community as 2008 began. Yet commodity and equity market participants paid only modest attention to the mostly conservative economic forecasts. Commodity prices, in fact, showed surprising resilience well into the second quarter, some reaching record highs, seemingly impervious to the squall that would level the market in the third quarter.

In July, when copper prices approached their cyclical high of almost $9,000 a mt, "few in the industry were considering the likely shape of the impending recession," GFMS Metals Consult­ing (London) noted in a November report. As late as last April, at ReMA's convention, industry analysts said the domestic and international steel markets would be "stronger for longer" based on assumptions of increased global steel consumption, positive demand for U.S.-based scrap supplies, domestic capacity constraints, higher steelmaking costs, and a shrinking pool of available scrap resources. Many believed that global supply-demand fundamentals for base nonferrous metals, steel, and recovered fiber would outweigh the effects of the turmoil in the global credit markets.

As we now know, the market crisis morphed late in the third quarter into an unprecedented multitrillion-dollar global recession, led by the financial sector. What did so many analysts—and recyclers—miss or ignore in this startling economic about-face? In part, the answer originates in the low U.S. interest rate policy of 2002-2005, the government's financial deregulation and the subsequent unbridled credit expansion, and the U.S. trade deficit, which encouraged trading partners to lend surplus dollars. In other words, cheap money, lax lending practices, and little regulatory oversight fostered irresponsible lending—and equally irresponsible borrowing—to the point where it became nearly impossible to assign a value to toxic mortgage-backed securities and other assets tied to credit default swaps and other complex (and mostly unregulated) financial derivatives.

Balance sheets became frozen because no one could figure out who owed what to whom and whether anyone even had the ability to pay. Interbank lending stopped due to lack of trust. What started in the United States became a global problem because Europe and Asia also assumed risk with minimal governance and oversight. The resulting credit, liquidity, and solvency tsunami and the economic recession slammed asset values, prompting panic deleveraging in both commodities and equities.

The credit crisis and economic slowdown took a severe toll on all key metal-intensive markets—including construction, automotive, and industrial equipment—as well as transacted prices. Commodity prices plunged, resulting in widespread contract defaults, renegotiations, and cancellations for material already shipped. The London Metal Exchange base metals index declined 56 percent from its peak in the first quarter of 2008 to the end of November. Similarly, the Reuters/Jefferies CRB Index, a global commodities benchmark, gained nearly 30 percent in the first half but gave it all back by November. The downward trend also pummeled finished steel and ferrous scrap prices, recovered paper, crude oil, and the Dow Jones Industrial Average. In response, analysts began aggressively scaling back their 2009 forecasts.

In the big economic picture, the market shift meant that the previous synchronized global expansion devolved into a synchronized global contraction. This development discredits, to a large degree, the concept of "decoupling," which maintains that world economies are separating themselves from U.S. economic cycles. Global markets are all now in the midst of deleveraging, deflation, and depression. As Macquarie Research (London) observes, "This downturn is taking place in every single region of the world, highlighting the global synchronized nature of the slowdown, and has been devastating for the raw materials suppliers to the steel industry."

Looking ahead, 2009 is likely to bring only a gradual recovery in growth as measured by global gross domestic product, according to the November 2008 macroeconomic outlook by the International Monetary Fund (Washington, D.C.). After rising 5 percent in 2007 and an estimated 3.7 percent in 2008, global growth will climb a modest 2.2 percent this year, the IMF said. Looking just at advanced economies, the IMF forecasts that GDP will contract for all of 2009, the first decrease in the post-World War II period, with the U.S. economy expected to decline 0.7 percent.

Along the same lines, the 30-member Organization for Economic Cooperation and Development (Paris) foresees the most serious recession among developed countries since the early 1980s. The group expects the gross domestic product of OECD countries to decrease 0.4 percent this year before rising 1.5 percent in 2010. Like the IMF, the OECD expects U.S. GDP to contract in 2009—by 0.9 percent—then increase 1.8 percent in 2010.

Merrill Lynch (New York), meanwhile, painted a more pessimistic outlook for the United States. In its November/December 2008 Advisor, the company estimated the U.S. GDP would slip 1.7 percent in 2009. Goldman Sachs (New York) forecasts a similar 1.6-percent decline in U.S. GDP this year, along with an unemployment rate of 8.5 percent. Almost as a moot point, the National Bureau of Economic Research (Cambridge, Mass.) announced in December that the United States officially is in an economic recession. The group, a private, nonprofit research organization, said the recession began in December 2007, ending an economic expansion that started in November 2001.

Looking beyond the United States, the World Bank (Washington, D.C.) cut its 2009 GDP forecast for China to 7.5 percent, reportedly its slowest growth rate since 1990. Last October, the IMF also scaled back its projections for China from 2007's strong 11.9 percent growth to 9.7 percent in 2008 and 9.3 percent in 2009. Most private forecasters are far more bearish about China's export-driven economy.

The principal concerns now are how severe the current recession will be and how long it will last. Basically, there are three possible scenarios for the economy and the scrap commodity-intensive industries. The first and most pessimistic is a protracted economic slump that, if charted, would resemble the letter L. The vertical line of the L represents the price response for many commodities since October, when prices for primary metals and many scrap commodities dropped like stones. The horizontal line of the L assumes that prices will hit a floor, then remain flat for a protracted period. In this case, some companies would be unable to meet their production costs, which would lead to closures along the supply chain. The market would eventually recover, but only after the flat-line period stretched out for years, effectively negating the recent years of rising commodity prices.

The second scenario resembles a V, suggesting that despite the sharp drop at the outset, prices and markets will bounce back sooner rather than later, and with almost equal strength. Though November showed some recovery in metals and equities, last year's fourth quarter showed little convincing evidence that either the larger economy or commodities would mirror the upside of the V. (Some also see W as a potential market shape, suggesting ongoing market volatility.)

The third and final shape resembles a U, and this scenario is the prevailing outlook for 2009 and 2010 of most mainstream economists. Following the declines in the third and fourth quarters of 2008, the markets could test the bottom for a time—perhaps through mid-2009—then begin a gradual upward climb. Clearly, this is a conservative—but also a more hopeful—perspective.

With those potential scenarios in mind, here's a review of forecasts for nonferrous metals, steel, and recovered fiber for 2009 from a U.S. market perspective, and a look at how these forecasts compare with predictions for 2008.

Copper
Reuters' July 2008 survey of some 40-plus commodity strategists provides a reference for the mood back then and what the consensus guess was for copper for 2009. Prices for refined copper softened in the second quarter last year as market participants struggled with various global influences, including record crude oil prices, currency considerations, and ongoing macroeconomic worries. Lower consumption in Asia and other industrialized nations reduced demand for refined copper and scrap, subsequently boosting stocks on the commodity exchanges.

Even given last year's uncertain global fundamentals and credit worries, Reuters' July survey projected copper's 2009 average at $3.51 a pound. As the fourth quarter began, however, copper prices collapsed. Comex spot copper, for example, fell 46 percent from end-2007 to end-November 2008. Thanks to its record summer highs, however, copper still managed to average just over $3.30 a pound in the January-November 2008 period.

As of last November and December, the price predictions for 2009 ranged from a low of $1.60 by Cochilco (Santiago, Chile) to $2.70 by Mitsui Bussan Commodities (New York). Catherine Virga of CPM Group (New York) reported that copper could test its marginal cost of production—which she placed at $1.15—early in 2009. Goldman Sachs offered a more optimistic view, seeing copper returning to the $3 level by October. That said, the average among the half-dozen or so analysts referenced for this article was $1.85 for this year, with weakness most pronounced in the first half.

Aluminum
The Reuters' July 2008 survey offered a consensus aluminum average of $1.46 for 2009 based on several market factors at that time, such as firm second-quarter 2008 prices thanks to fast-rising energy costs and subsequent smelter curtailments. Despite this price firmness, market participants disagreed about aluminum's fundamental balance for the remainder of 2008, especially in light of its relatively large aboveground inventories and modest North American consumption prospects. Early in the third quarter, however, sentiment turned decidedly bearish against all commodities.

As you'd expect, several analysts revised their 2009 projections in the final months of last year, with most published forecasts anticipating an LME cash average between 90 cents and $1 a pound. Barclays Capital (London) forecast a 92-cent average, while both Canaccord Adams (San Francisco) and Macquarie Research expect a slightly lower 90-cent average. Last year's forecast article projected a 2008 average around $1.14, and the actual average price was $1.07 through November.

Iron and Steel
The domestic steel market took a breather in the third quarter of 2008, though Midwest hot-rolled coil prices (f.o.b.) were still around $1,000 a ton, up 85 percent since the start of the year and more than double the previous year. As the market breathed, ferrous scrap prices eased, dragged down by obsolete grades such as heavy melt and shredded. Overall market sentiment, however, expected a positive fourth quarter based on domestic demand, lower imports, and increased export opportunities. At midyear, Goldman Sachs projected domestic HRC prices at $1,000 a ton in 2009.

How quickly sentiment changed. By the fourth quarter, the market was struggling with deteriorating demand for finished steel, plummeting prices for steelmaking raw materials, and industrywide destocking. Midwest spot prices for HRC were $600 a ton or less in early December, and No. 1 heavy-melt scrap fetched $185 a gross ton, delivered (though that grade slipped below $100 a gross ton in mid-November). Goldman Sachs' December forecast called for HRC to bottom out in December at $525, with "some transactions" falling below $500 before temporarily recovering.

For 2009, several industry analysts predict a $500 bottom for HRC, according to Steel Business Briefing. Their logic is that at $500, steelmakers are "just above the break-even point for mill production costs." Other sources are less pessimistic. Purchas­ing magazine, for example, sees HRC averaging $610 in the December 2008-February 2009 period. Goldman Sachs' Sal Tharani expects domestic HRC prices again to ease to the $600 level by "early 2009." Due to a temporary supply-tightening scenario in the first quarter, prices could firm to $675 by the end of the quarter before falling back to $500 in the summer. For the year, Tharani predicts a price average of $560, one-third lower than his estimate for 2008. He also sees domestic steel production declining 7 percent to 10 percent this year.

As for ferrous scrap, No. 1 HMS could average $185 a gross ton in 2009, increasing to $215 in 2010, Tharani says. Morgan Stanley forecasts that shredded scrap will average $228 a ton this year, down 44 percent from its 2008 estimate of $410. More bullish, GFMS Metals Consulting sees shredded averaging $270, ex-yard, Midwest.

Looking ahead, the global steel industry could be in oversupply for the next one to two years, according to Peter Marcus of World Steel Dynamics (Englewood Cliffs, N.J.). Nevertheless, he argues that finished steel prices will recover by late 2009. Scrap prices will respond accordingly, he says, with No. 1 HMS rising to $240 a gross ton, shredded scrap hitting $270, and prime industrial scrap commanding $320. Both Tharani and Marcus expect lower global steel production in 2009, with the decrease ranging from 6.3 percent to as much as 22 percent—much steeper than the projected 1-percent decline in 2008.

Nickel and Stainless Steel
Midway through last year, analysts projected lower demand from the stainless steel sector, which accounts for about two-thirds of global nickel consumption. Nickel price forecasts reflected that cautious sentiment, with Reuters' July 2008 survey pegging LME cash nickel at $11.66 a pound for 2008, well below the metal's 2007 average price of $16.86. Halfway through the third quarter, LME nickel prices were trading at a two-year low below $8 a pound, down more than 50 percent from its high of $16.30 earlier in the year. As December began, LME nickel had slid to about $4.60, down more than 60 percent from its year-end 2007 price of $11.71.

Despite some expectations of recovery late last year, nickel supplies appeared to be more than enough to meet the demand of stainless producers. Speaking at the November meeting of the Bureau of International Recycling in Düsseldorf, Germany, Michael Wright of ELG Haniel Metals (Sheffield, England) expected little market improvement until the second quarter. Stainless production could slip to 26.4 million mt this year from the projected 2008 total of 27.3 million mt, he said. Nickel-containing stainless also could see its share of production fall from an estimated 59 percent in 2007 to 55.4 percent in 2008, Wright said.

Keeping nickel's inherent price volatility in mind, price forecasts for this year ranged from just under $5 to a high of $7.67 a pound, significantly down from earlier expectations as well as the LME 11-month 2008 average of about $10 a pound.

Lead and Zinc
Among the nonferrous base metals traded on the LME, lead suffered the second-largest price drop, 57 percent, through November last year (trailing only nickel, which declined 62 percent in that period). LME zinc inventories, meanwhile, increased nearly 120 percent through November as LME cash zinc prices dropped 48 percent.

Lead showed uncharacteristic volatility last year, both in price and inventory changes, mostly based on uncertain supply from China, the world's largest refined lead producer. Through November, LME cash lead averaged $1 a pound. The Reuters July survey forecast lead to average $1.05 last year and 86 cents this year.

For its part, the zinc market was weighed down by mid-2008 data that placed the global market in surplus, along with rising LME inventories. Reports of possible Chinese production cuts offered some price encouragement, but sentiment toward zinc remained bearish due to the perception of abundant aboveground supplies and weak demand. Analysts projected that zinc would average under $1 a pound last year compared with a 2007 average of $1.47.

Price projections for lead and zinc dropped sharply following Reuters' July survey. LME lead is again expected to fare better than zinc this year, with a 2009 consensus average of 71 cents. Barclays Capital, Macquarie Research, and Canaccord Adams see the average closer to 60 cents. Zinc's 2009 price projections range from 50 cents to a high of 88 cents a pound, with Barclays predicting a 60-cent average.

Pulp, Paper, and Recovered Fiber
Pulp prices, as measured by northern bleached softwood kraft, averaged $825 a mt in 2007 and posted another increase last year to $858.50. The pulp market optimistically looked to build off firm global demand and relatively low producer stocks, factors that defined the market in 2007 and the first two quarters of 2008. Through June of last year, NBSK averaged $880, surprising some who expected prices to soften in response to increases in global pulp capacity.

Like other commodities, market pulp and recovered fiber saw their prices nose dive in the third quarter last year as paper and paperboard demand stalled in the second half. North American list prices for NBSK slipped to $870 in September, ending the year at $730 to $750—a level not seen since the summer of 2006. Paper packers felt the effects of the fast-changing fundamentals and mounting scrap supplies in the second half of last year. Consequently, domestic scrap paper recovery was not expected to surpass the 54.3 million tons recovered in 2007.

Scrap paper prices for both domestic and export markets fell much harder as last year wound down. Old corrugated containers were at $20 to $25 a ton, picked-up, Midwest, in early December, down as much as 80 percent from the previous $95 to $100 mark. West Coast OCC export prices eroded from $180-plus at the pier at midyear to the mid-$60 range by December. Midwest mixed paper quotes fell to a range of zero to $5 a ton, picked up.

As 2008 ended, paper markets faced a host of challenges, including reduced export demand from China, well-stocked containerboard mills in North America due to weak box demand, and lower newsprint consumption. Those factors resulted in mill downtime and, hence, an oversupply of scrap paper. Price forecasts for NBSK and recovered fiber reflect these challenging conditions, with most analysts noting that the U.S. economy must recover before the paper industry can respond, as the two move in close correlation.

Going forward, China is the big question mark for paper recyclers. If it resumes buying in early 2009 at the same rate as its purchases in 2007, prices for mixed paper, OCC, and ONP could recover quickly.

Robert J. Garino is director of commodities for ISRI.