Steel Bubble?

Steel Bubble?

By Duru

July 4, 2005

By now, most of us have heard of the woes experienced by America's two remaining car companies, GM and Ford. It goes without saying that if American car companies suffer, steel will suffer. U.S. Steel Corporation supposedly does a lot of business with GM. The weekly graph below shows that for the past 13 years, the fortunes of the two companies have been closely linked with only two exceptions. (The y-axis is logarithmic to make comparisons easier. Each "tick" is a move of 1.25% in price). From 1995 to 2000 GM's stock rose slowly but steadily while U.S. Steel's stock declined slowly but steadily. We can think of this as a period where GM benefited from the woes of one of their suppliers. From 2004 to around March, 2005, the stock of U.S. Steel and GM experienced an extremely sharp divergence. GM spent 2004 trapped in a tailspin as the price of steel continued to soar. One very steep correction in U.S. Steel in 2004 simply led to an equally sharp snapback on the way to ever higher prices. These higher prices finally took their toll on GM (combined with a host of other poor business conditions) leading to a horrific earnings warning and steep correction on March 16, 2005. This collapse essentially confirmed the top in steel. Steel could only extract so much from its customer base after all. The recent recovery in GM remains well-contained within the downtrend in place since 2000, so we should consider the outlook for steel to remain poor.

As I noted earlier, March marked a month where I finally got serious about commodities. My timing could not have been worse. Heck, even Doug Kass fought the growing consensus as he proclaimed in a March issue of Barron's that steel had topped. Regardless, I have learned a lot while watching steel quickly fall apart. It turns out that there has been a bubble in steel prices, and, as so often happens with bubbles, an abiding faith in the alleged fundamentals provided all the rose-colored blinders I needed to ignore the danger all around. However, as many steel stocks print out classic bubble patterns, even the worst collapses have only brought steel stocks back to the average levels seen in 2004. Our conclusion then is that either the bubble has not finished popping and more pain lies ahead, or that there was only a sharp pullback in a market that temporarily got ahead of itself. For example, the commodity index has not followed steel downward. The commodity index, shown below in a 9-day chart, indicates that the bull run in commodities from the 2001 bottom continues.

Certainly the Fed sees charts like this and sees the need to continue hiking short-term interest rates. Sectors like steel that are weakening should only get weaker under such conditions. I print below several charts of steel stocks that I follow to show how mixed the two-year story appears. We have steel stocks which have clearly popped short-term bubbles. We have stocks that have been making slow and tentative recoveries from catastrophic lows in March (see an earlier posting for a more detailed look at the charts of Oregon Steel). Finally, we have stocks whose long-term story amazingly remains intact. You can be the judge, but isn't amazing that so many public steel companies remain after all that angst we saw earlier this decade over bankrupt steel companies and chronically poor financials?

Also realize that in these days and years of bubble-talk, we have become highly sensitized to what appear obvious bubbles (like housing prices around the globe and some think oil prices are extremely over-extended), and nearly oblivious to potential bubble-like conditions that remain off our radar because we consumers do not purchase these goods directly.

Oregon Steel dropped about 50% in less than three months. Despite this bubblicious looking chart, prices have merely returned to levels last seen in the fall of 2004.

The close-up of Oregon Steel shows the development of a "do-or-die" situation. The stock is below the (still rising) 200-day moving average, struggles to cling to a declining 50-day moving average, and tries to climb a recent up-trend in recovery from the sharp two-month collapse. I suspect an answer is around the corner…

CMC tries to hold the gap up from late 2004 that marked the beginning and end for this bubble.

NUE is in a similar situation to CMC. While a mini-bubble has clearly popped, there remains plenty of downside. Erasing 2004's run would mean an additional 40% price drop.

Scrap metal has been scrapped. An eradication of 2004's prices happened extremely quickly after SCHN failed at the highs printed in January of 2004. Stay tuned on what the market chooses to do with 2003's prices. SCHN started that year at $6.67!!!

STLD has been fessing up about poor results recently. STLD's bubble was extremely sharp. The complete destruction of 2004's prices is only another 20% drop away.

And we end this horror show with one steel stock that refuses to give up. While it experienced a quick run-up in price from February to March, this run was "only" around 25%. The return to normalcy has simply returned the stock to a year-long trading range. The company continues to insist that things look pretty good, so 2004's prices still seem safe. So stay tuned on this one!

As always, be careful out there!