If you’re following along with the financial media, you probably saw a lot of commentary about how Wednesday’s Consumer Price Index (CPI) report was “good,” or at least “better than expected.”
Source: CNBC
The new infrastructure bill has also been dominating headlines, and the media seems excited about that as well… But as usual, there’s a key component the talking heads are missing about infrastructure and inflation.
While many are indeed desperate to qualify the Federal Reserve’s “transitory” narrative, they persistently fail to recognize that the word “transitory” simply means “not permanent.”
Of course prices won’t go up forever. That’s not what the overarching concern is.
Rather, the concern has always been, “Where does price inflation stick?”
Because if it sticks anywhere near the 13-year high we’re currently at, that would be the polar opposite of “good.”
Source: Bloomberg
We can see why all of the talking heads were pleased if we look at a heatmap by CPI components. On a monthly basis, it’s clear that inflation accelerated through peaks (shown in green) in May and June, and began to decelerate (fading toward yellow) in July.
Source: BoA, BLS
Other than energy, medical care, education-related commodities/services, recreation and other personal services, almost every metric pulled back on a month-on-month basis.
But when we zoom out to the bigger picture — by viewing the same data on a year-on-year basis — a very different picture emerges.
Source: BoA, BLS
In this view, almost every metric is either accelerating to its highest (darkest green) level, or sticking close to its recent peak.
Moreover, both headline and core CPI are accelerating on a two-year annualized rate, meaning that inflation is trending relative to pre-pandemic levels.
Let that sink in for a second…
Even adjusting for market lows caused by COVID-19, inflation has ramped up to the point where it would be problematic even without the pandemic.
And what literally everyone seems to be missing is the relationship between infrastructure and inflation. The bill recently passed by the Senate is poised to keep inflation rates higher for longer.
Infrastructure and Inflation: What Everyone’s Missing
If you’ve been reading my work for a while — either here at Fortune Research or over at Venture Society — then you know I started my career as an industrial analyst at a major global research consultancy.
Specifically, I covered steel and steel raw materials — iron ore, scrap, metallurgical coal — all of which will consume a significant percentage of the $1 trillion infrastructure package.
In fact, Nucor CEO Leon Topalian — the largest steel producer in the U.S. — was just on CNBC’s “Mad Money” last night, saying how the steel-maker is ready to help “rebuild this nation.”
Well, if you look at a pricing chart of U.S. hot-rolled coil, you can probably see why he’s so excited.
Source: Bloomberg
Steel prices have gone full hockey stick to an all-time high of $1,881 per ton.
And when I say all-time high, I mean never in history have prices even been close to where they are right now.
History, in case you were wondering, is a long time.
So while I appreciate the patriotism inherent in Topalian’s statement, I recognize that he’s also ready to rebuild his wallet.
Steel’s massive price inflation is a key reason why construction companies haven’t seen overall costs decline following lumber’s “collapse” back down to its long-term inflationary trend.
And unlike the lumber industry, whose primary bottleneck was labor and transportation, the primary bottleneck of the steel industry is the industry itself.
Increasing production requires super long lead times… Because idle blast furnaces can take a week or more to heat back up — even longer if they’ve been idle for years.
Even electric arc furnaces like Nucor Corp. (NYSE: NUE) operates — which can be turned on at the flip of a switch — require sourcing quality scrap steel. That supply chain has also suffered from delays and labor issues.
As a result, the infrastructure bill’s requirement that its projects use 100% domestic steel is likely to crunch supply even further in the short term, causing domestic prices to remain at these elevated levels…
Infrastructure? More Like Infla-structure
Infrastructure and inflation go hand in hand right now.
And just take a look at our prices versus steel being traded in the seaborne market (on boats) or in China.
Source: CME, Seawolf Research
That difference is absolutely enormous.
Moreover, China’s ruling Communist Party is planning to tax steel exports in an effort to stave off inflation.
While that will likely push Chinese steel prices lower, it may serve to push global seaborne export prices higher.
Moreover, with former President Donald Trump’s infamous 20% steel import tariffs still in place, that means there won’t be as much room for U.S. prices to come down, even if we do manage to get a production increase.
And in turn, items reliant on steel — appliances, new cars, energy and, yes, even housing itself — aren’t likely to get any cheaper any time soon.
So as much as I’d like to read the data as “positive” or “better than expected” like all those talking heads today, I just can’t.
Because I’m thinking about what prices are going to look like going forward as infrastructure and inflation play off one another.
And those yabbos are looking at a CPI number that only shows us what’s in the rearview mirror.
How to Play Infrastructure and Inflation
While stalwart rebar producers like Nucor and Steel Dynamics Inc. (NYSE: STLD) have already gone to the moon, there is one major U.S. manufacturer that’s been flying under the radar.
The primary reason, however, isn’t because of anything negative… It’s just because they’re actually Brazilian.
Gerdau SA (NYSE: GGB) is the largest long-steel producer in Brazil. But it also happens to be the third largest longs producer in the United States.
While it does carry some currency risk, it has yet to go full hockey stick like its competitors have.
Source: Bloomberg
Whether that’s because Gerdau hasn’t reported yet, or is just under-covered in general doesn’t matter to me… I like the relative value. A quarter stake should get us started here, and we will adjust depending on near-term price action.
Go get ‘em!
All the best,
Matt Warder
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