Seeking Alpha
What is your profession? ×
Long/short equity, arbitrage, event-driven, research analyst
Profile| Send Message|
( followers)

Upon publishing my article "Steel Is In China's Hands" I received dozens of comments and feedback. My theory in that article was that given China's dominant position in the world's steel market, where it accounts for around 46% of the entire world output, and the expected slowdown in China's economy, whose expansion is dominated by investment, it was likely that the world would see an extraordinary oversupply of steel. This meant that although steel shares have been thoroughly punished already, their upside can be limited and there might actually be a lot of potential downside.

I expected a strong reaction, and the reason is simple. If the present steel cycle was like past steel cycles, we should instead be talking about the upside that these shares have. With the auto and housing markets on the U.S. in the mend, steel demand in the U.S. is sure to go up, and is already going up. Utilization rates in the steel mills are going up, and scrap prices are moving northward as well.

Put this together with a hot stock market looking for stocks to buy, and sure enough, a lot of people would be taking positions in these stocks to avail themselves of the almost inevitable short term rallies that were sure to follow. And even just these traders and investors taking position were already enough to have built a positive trend into some equities, for instance, US Steel (NYSE:X) is already trading 50% above the low levels it hit back in September, AK Steel (NYSE:AKS) is up 74% since then, Arcelor Mittal (NYSE:MT) is up 41% and Nucor (NYSE:NUE), +45%.

Yes, I put forward some data, regarding the Baltic Dry Index and auto production in China, which showed that something was amiss. But my general theory really is going out on a limb, so strong is the evidence that locally (in the U.S.), the sector is heating up.

So I feel it necessary to show something else, to again reinforce that something really is amiss, that notwithstanding the obvious sectorial strength in the U.S., there is an emerging problem with steel, or to be more precise, steel prices.

Steel prices are always hard to find, very few standardized contracts exist, and steel comes in many forms and flavors. Yet, some prices are possible to be found. For instance, a contract for steel billet trades in the LME. And what is it showing? This:

There are also specialized sites, most requiring expensive subscriptions to access the most current prices, yet on worldsteelprices we can get prices for several steel products that are less than one month old. What do they show? The same thing as the LME:

Conclusion

While recognizing that traditionally the present timing would be one to buy steel stocks due to their cyclicality and economic sensibility, again I must emphasize that China's scale in the steel market is such that it should override locally positive development, such as the ones that would lead us to buy steel stocks at their present levels. China's relevance is not just theoretical, and its impact can already be seen in worldwide steel prices, even if locally there can still be some markets that are not yet fully influenced by these pricing moves.

As such, care must be taken when trading the sector from the long side, knowing that any kind of weakness in the share prices might be other than temporary. There is a high likelihood that steel prices will fall even harder to the point where most producers will be operating at a loss. Such possibility is not yet reflected in steel producer's earnings estimates or share prices.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.