Mr. Fletcher: I think there a number of things. The stocks rallied about a month or two ahead of schedule, particularly in November last year, when it looked as though investors were looking for growth. There was a kind of dumbbell strategy where you had people interested either in organic or technology driven growth on the one hand, and earnings driven growth on the other, and in the middle was left anything with margins growing like utilities or financials, and the stocks did well. They, if you like, anticipated their usual first quarter rally, and so that didn’t happen. Why have they performed so dismally since? I think it’s a number of factors. The first is uncertainty on the fundamentals, particularly in the US, where obviously as soon as you start to think about a hard or a soft landing you kind of want to shy away from these things. If you looked at the bond yields, the mortgage swaps market, and things like that, they were approaching a hard landing, which clearly was not very good for these things. So there’s that uncertainty overhanging them, particularly in the States. That uncertainty about what was going to happen in the States obviously started crossing over to the European sector, although the fundamentals actually turned out to be completely different. Those worries in the US at the macro level were then further boosted, again solely in the US, by micro factors, in particular, the clearly worrying and fairly visible excess inventory build, which resulted in all-time record-high inventories in the States fueled by domestic overproduction. If you looked at the half-year stage, US crude steel output is up 14% year on year and at the end of the first quarter it was up 15.5%. It hasn’t slowed down much, and clearly that rate of increased output is far greater than any likely level of organic demand growth. At the same time, because the dollar remained strong, you had rising imports, which suddenly were up about 25% year on year the first quarter and then suddenly, in April and May, spiked up 45%. The main number in absolute volume terms is down on the April number about 6%, but it is still high. You’ve got a big supply side issue irrespective of what is going to happen on the demand side, and I think the risk, which is feeding across from the US into Europe, is that if you start the second half with a supply side problem and you believe that the US economy is going to slow down one way or another, either dramatically or gradually, you have the risk of adding a demand side problem to that supply side problem, in which case steel prices are going to come off pretty heavily. Now, in Europe the fundamentals are different. There is no excess inventory situation. Demand is very robust, and if you look at a chart, and that’s basically a function of the exchange rate, if you look at the euro-dollar exchange rate over time, that synthetic euro dollar versus German industrial output, the correlation is almost exact with a six-month time lag. If you look at German industrial output, manufacturing orders versus European crude steel output, again the correlation is almost perfect. So you have a weak euro, a booming German industry, strong steel demand with steel output remaining relatively restrained. And imports, clearly with the weak euro, have not been a major factor. The bear case is that any real macro weakness in the US will be bound to spill across to Europe, and that, historically, there has never yet been a cycle where you’ve had an excess inventory situation in the US, which hasn’t resulted in a similar situation in Europe some six months later, so that worries too. Plus, a big issue is the spot price differential. Obviously, the spot price differential flip flops between Europe and the US depending upon the timing of the respective cycles. Before US spot prices started coming off, in dollar terms, there was a very healthy price differential with US prices peaking at about 80 a ton above the European price, which is more than the freight costs. But it looks as though there was plenty of room for maneuver to bring European prices up further even though in local euro terms they are at previous peaks, right about 340 to 350 euros per metric ton. As soon as spot prices came off, you began to think of the situation where that gap could close and all you needed was a 10% strengthening of the euro, for example, coupled with 20 a ton off the US spot price, and suddenly you’d be in a situation where the European spot price was higher than the US one in dollar terms, which would probably lead to repatriation of exports out of Europe. So more supply into Europe, plus at the margin you can imagine that the imports into the US from third countries like the CIS, Mexico, Brazil, and Russia would redeploy into Europe. The selling price would be a bit higher. If that happens, then again, your scenario would be that the European prices would start to fall or you would stop getting excess inventory built. So far, that hasn’t happened, but the jury is out. There are clear signs the European market has at least plateaued. Nobody really believes that selling prices are going up a lot more. Volumes, we’ve just had data out today from Usinor (13260.PA) showing that actually in the sector quarter their hot rolled output was actually down on the first quarter, very marginally, only 3% or 4%, because the restocking after the Asian crisis is now over and therefore people are trying to adjust production levels to actual final demand, because they don’t want to get an excess inventory situation. That suggests that the volumes have plateaued, too. So, although the stocks look incredibly cheap, it’s not clear where the upside is from here, and you’d have to argue that the risks are that on the downside.
Tickers included in this excerpt: 13260.PA, 750000.F, 894577.F
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