Shapiro Metals – March Market Insights

“The only certainty is that nothing is certain.” -Pliny the Elder

“Not since the end of World War II has Europe seen violence and naked territorial ambition at such a scale.”  -Andriy Yermak, head of the Presidential Office of Ukraine.    

The war in Ukraine has become a global crisis creating seismic shifts in nations’ economies. Putin murdering innocent Ukrainian people for reasons that only make sense to him has caused a humanitarian nightmare. Europe, the U.S., the U.K., and the rest of world joined together and are standing up to him and will stop him.  

This will be painful for everyone. Many Ukrainians and Russian soldiers will die needlessly because of Putin’s ego. This war will be very costly in humanitarian and economic terms for Ukrainians and the entire world. However, if we don’t stand united now, the cost will be immeasurably worse later. History taught us this when we didn’t stand up to Hitler early.   

Geopolitics 

For centuries, Russian leaders have viewed control of Ukraine, the Crimean Peninsula, and access to the Black Sea as vital to the country’s security and interests. Peter Zeihan, an American geopolitical analyst, said: “But unlike his predecessors, Putin’s working with a terminal demography. Russia’s geography certainly hasn’t improved, but in the years since the collapse of the Soviet Union in 1991 a collapsing healthcare sector, skyrocketing alcohol and substance abuse, falling birthrates, declining life expectancies, and the ravages of disease – including tuberculosis and HIV/AIDS – has left Moscow to secure vast territories with a shrunken, and shrinking, military. If Russian geography can help explain the why of recent aggression, Russian demography can help us understand the timing. It’s now or never, and for Russian leaders the latter isn’t an option.” 

 Russia has a strong military, and unfortunately nuclear weapons, but it is only 2% of the world’s GDP. Its main source of revenue is natural resources: oil, natural gas, aluminum, nickel, and a few other commodities. Its commodity-driven economy is now being financially choked as the U.S., European nations, and most other countries in the free world impose strong sanctions on Putin and his oligarchs. These measures will severely affect the Russian economy and people. This war has ended Russia’s partnership with Europe. European nations have been energy dependent on Russia for a long time, but they will struggle to trust or depend on Russia again. Russia’s only other viable economic outlet is China. But it is in China’s best interest to have a world at peace considering its economy is 18% of the world’s GDP and is heavily dependent on exports. 

 All crises end, and this will too. Just as supply chain issues taught us the importance of being less dependent on other nations, Russian aggression is teaching us to be wary of dishonest autocrats and their promises. Because of Putin’s actions, Russia faces higher inflation and a severely handicapped economy as the world isolates the country financially and socially. Russia can and will use cyberattacks on the western world to “fight back.” The situation is going to get ugly and we will see many currently unknown consequences. 

The sanctions have caused energy and commodity prices to skyrocket. Ukraine is a very large producer of agricultural commodities, and those prices also have risen. While we will pay more for our food and energy, 44 million Ukrainians will have difficulty even finding food.   

Putin overestimated the strength of his military and underestimated the response of Ukraine and the free world. Ukraine is putting up a tremendous fight and resistance to Russia. Russia has tremendous fire power and will continue its vicious attacks until it can “win” the war. Putin is willing to sacrifice whatever he thinks is necessary to win. At some point, China, his main ally, may be able to influence him to change. I believe this is the best option. 

Employment and COVID-19 

The shortage of labor has slowed the economy for the last 18 months. The Covid pandemic started two years ago, and the government began distributing stimulus money 18 months ago. The rapid, continuous declines in virus cases, lifted mask-wearing restrictions, and people returning to work are all good signs.  

• Almost 700,000 new jobs were created in February, dropping the unemployment rate to 3.8%.  
• Hourly wages are up 5.1% from a year ago, lagging inflation.  
• Hours worked are up 5.5% in the past year and are now only 0.2% off the pre-Covid peak.  
• There are still 1.2 million fewer people employed compared to before the pandemic. Much of this is due to The Great Resignation; I believe some of these people will now return back to the labor market due to inflation or boredom.   

Covid cases have dropped sharply and the virus is transitioning from a novel, pandemic stage to endemic, where the virus is widespread but constant and predictable. Covid cases will still occur and too many people will die, but the virus will be more comparable to the flu prior to the Covid-19 outbreak. At least, I hope. 

Inflation

Prior to the Putin invasion of Ukraine, inflation talks focused on what the Fed was doing and if it was enough. Could the Fed thread the needle to keep inflation in check without substantially hurting the economy? Today’s issues make those times look easy. The word “unprecedented” has been overused during the last 2 years but is still very relevant.  

The February inflation numbers will be out around the same time as my March Insights, and they will look “good” compared to what will happen in March. The effects of the Putin war are that not only are oil prices spiking, but also prices for wheat and corn, of which both Russia and Ukraine are major producers. 

The Fed’s Personal Consumption Expenditures [PCE] index, which excludes energy and food prices, will start coming down as some high-cost items — like new and used cars — “look” lower priced later this year. That is because they will be compared to the price 12 months ago when new cars were in short supply and used car prices consequently spiked. My issue with using the PCE instead of the CPI is that most people see the prices of gas and food going up on a regular basis. Price changes make most people feel insecure even if their wages have gone up,  impacting consumer confidence and the demand for goods and services. Small business optimism fell to a one-year low in February as businesses struggle with surging prices and inflation fears. 

Manufacturing 

Shipments of “core” non-defense capital goods excluding aircraft (a key input for business investment in the calculation of GDP) rose 1.9% in January, the largest increase in 12 months. If these shipments are unchanged in February and March, they will represent a 13.2% annualized gain in Q1 versus the Q4 average. The ISM for February indicates we are still in expansion, as the index moved up to 58.8. The two most forward-looking indices, new orders and production, posted gains and remain well in expansion territory. The usual suspects of labor, supply chain, and logistics are still issues but improved slightly. The January Total National Producer Price Index, including oil, registered a monthly increase of 0.61% and an annual increase of 9.78%. The main issues will be the insane metals and energy prices. More on that later.  

The ITR Leading Indicator™ index moved lower in February, marking eight consecutive months of decline. However, their forecast for U.S. industrial production points to slower growth into at least late this year. The Shapiro Nonferrous Scrap Activity Index for February was the same as January, which was down 5% from last year’s average for the same accounts. 

China

Although China’s GDP was up 8.1% last year overall and up double digits in the first half of the year, its growth in the second half of the year was only 4%. China has forecasted 5.5% growth this year, which is below its normal 6% to 6.5% annual growth rate.  

China’s housing industry accounts for 25% of its GDP. The surplus of unsold housing is enough to accommodate 10 years of urban immigrants and enough to house the entire population of France [I would rather be in France]. Housing also represents 70% of household savings. China’s housing sales have contracted close to 50% in the last eight months. This decrease will greatly impact the consumption of major housing components: aluminum, copper, and steel. The lower demand will also be a drag on prices later in the year.   

Metals

Metal prices and commodity prices are being driven by the Russian invasion and a fear that Russian aluminum, copper, nickel, and energy will not be available. According to Edward Meir, “Russia and Ukraine supply more than a quarter of world wheat exports, a fifth of corn sales, 6% of the world’s aluminum, 2% of nickel, 4% of copper and roughly 10% of oil. Europe depends on Russia for around 35% of its natural gas as well.”  

• Just before Putin invaded Ukraine on February 23, copper was $4.51 per pound, oil was $91 per barrel, LME aluminum was $3,250 per ton [$1.47 per pound], and nickel was $24,400 per ton [$11.08 per pound].  
• This week, copper was over $5 per pound, oil was over $130 per barrel, LME aluminum hit $4,000 per ton [full price at $2.20], and nickel was over $100,000 [$45.40] per ton.   

All March scrap prices are stronger. Prime aluminum scrap prices rose about 10 cents per pound, and secondary rose 5 cents per pound. All the other nonferrous prices also were up accordingly. Steel prices are substantially higher in March after falling for a few months. During my more than 50 years in this business, I have never seen anything close to this before. We continue to take the conservative approach of hedging and turning our inventory as quickly as possible and focus on our business.   

The war is not only driving higher prices, but many financial funds also are buying commodities as an inflation hedge. They say the cure for high prices is high prices. With that, there will be demand destruction, further inflation, and eventually reduced commodity prices. 

Bob Stein, one of my oldest and dearest friends and now on the Shapiro team, just wrote this for an organization we belong to:  

“Like all of you, I am devastated by the events in Ukraine and the suffering that has been inflicted on its people by Russia. The stories are difficult to comprehend in a world that is supposed to have learned to make certain that such horrific events no longer had a place in our lives. Clearly, the message of world peace hasn’t reached the Kremlin as it has yet again invaded a neighboring sovereign state, creating a humanitarian crisis that is only in its very early stages.”  

I have been donating to the charities that support the Ukrainian people and hope you can too. 

“The price of freedom may be high, but never so costly as the loss of freedom.”  -Ronald Reagan 

 Life is good. Family and health are precious.   

Bruce Shapiro   

I apologize for not responding to previous comments, but my email was incorrectly listed in previous commentaries. It is bruce@shapirometals.com. Sorry about that, and thanks for reading my Market Insights. Comments are appreciated.   

This report was prepared by Bruce Shapiro and reflects my current opinion of the economy. It is based on sources and data I believe to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice.