The Global Steel and Coal Trade and China

Includes: AA, KOL, MEE, PKOL, SLX
by: Jim Delaney

The possibility grew yesterday of a goodbye for more of Dubai’s debt and although it’s not the Sixties, that S&P might say “peace” to Greece’s A- long term credit rating. For those who watch these things intently, Fitch made that move yesterday lowering the country’s sovereign rating to BBB+. (Isn’t it funny how aggressive the big three ratings agencies are becoming now that competition is heating up in that business?)

The dollar rallied as it is the thing most loved in times of crisis when investors are full of “fear and loathing” versus the rest of the time when it is most hated and investors use it to finance every carry trade imaginable and since the market cannot, or does not care to separate the reasons for why the dollar rallied. Gold melted, oil leaked lower and stocks stunk.

Gold and oil are not the only hard commodities that foretell the future of the global economy and two others that are inextricably linked, coal and steel, are the subject of today’s piece.

Michelle Applebaum, an independent analyst with Steel Market Intelligence in Chicago, believes global steel demand will hit new highs by 2011 helped not least by China’s infrastructure-heavy-economic-stimulus plan. The World Steel Association forecast an increase in demand of 18% for the metal in the Middle Kingdom this year.

A key component in making the metal is metallurgical coal or “met coal” as it’s known in the business. Massey Energy (NYSE:MEE) is a big producer of the stuff and Jeremy Sussman, an analyst at Brean Murray Carret & Co., “think[s] we are in the early stages of a game changing event.”

The basis for Mr. Sussman’s suspicion comes from a forecast by Kevin Crutchfield, CEO of Alpha Natural Resources (another met coal producer) who sees its shipments of the specialty carbon as high as 12MM tons next year up from 8MM tons this year.

Interesting in all of this is an effort by China to cut its steel making capacity as it now has the ability to produce 610MM metric tons a year which is about 100MM metric tons more than it can use.

Recent trade disputes concerning steel piping could be a clue as to what happens with that extra 100MM tons. These concerns were voiced by Thomas Danjczek, president of the U.S.-based Steel Manufacturers Association when he said: “Our fear and paranoia is based on what the Chinese have done in the past.”

The numbers carry even more weight when you consider that the Chinese Iron and Steel Association has already reduced exports to 4% of production this year, down from 13% last year according to a recent statement.

The CEC Strategy is currently long two of the three coal producers it tracks including MEE and six of the seven metals companies with the one neutral position being Alcoa Aluminum (NYSE:AA).

As the CEC Strategy is based on monitoring movements in the negatively correlated relationship between CDS spreads and equity prices, longs require the first to be falling while the second rises to be initiated.