The steel industry is on top but China is a risk in waiting

Rising global steel output does not appear to be worrying investors in steel shares. Although there are clouds on the horizon, such as fears of the Chinese economy slowing down and the trade wars unleashed by the US, steel prices don’t seem to be feeling the pain. If output keeps increasing and prices also remain stable or up, then earnings of steel companies will benefit. That seems to be the argument propelling steel shares up.

In July 2018, global steel output rose by 5.8% over a month ago, according to data from the World Steel Association. This was indeed lower than the 6.4% growth seen in the June quarter, but in absolute terms output rose sequentially. July’s output is also significant because it comes on top of a growth of 12.9% in the year-ago quarter.

Coming to China, there’s little sign that its efforts to halt polluting steel capacity are affecting its overall steel output. It appears steel plants that are unaffected by the cuts are ramping up capacity to fill the gap. In July, China’s steel output rose by 7.2%, just marginally lower than the 7.4% seen in June. Again, output was up sequentially.

While China’s steel output looks healthy, its demand for high quality iron ore—the grade quality can ensure plants stay within pollution limits—has risen. The sustained increase in steel output has also kept up the demand for iron ore, especially high-grade quality, and prices have been stable. Since raw material pricing is one of the determinants of steel prices, this has helped keep prices up.

There is a near-term factor at play. More severe pollution cuts will come once winter sets in, at which time there is a perceptible drop in output. Perhaps, some of the ramp-up is to maintain stocks to sell in that period.

This has caused some volatility in the market. A 20 August Reuters report said Shanghai rebar prices hit a seven-year high on supply fears, and hot rolled coils were at an all-time high. This did not last for long. On 29 August, a Reuters report said steel futures fell for the sixth straight session, on increasing fears that the Chinese economy may slow down in the second half.

Meanwhile, Indian steel producers are gearing to increase steel prices next month, according to a 28 August Economic Times report. Rising input costs and the depreciation in the rupee against the dollar are driving their actions. Companies will also be hoping they can increase prices on the back of healthy domestic demand. In April-July, output was up by 3% while demand was up by 8.1%, according to Joint Plant Committee data.

In a situation where output is growing and prices are increasing, steel companies should see their earnings grow. This explains why steel company shares are in demand.

The big risk on the horizon remains China. If its demand for steel slows down, it will have a ripple effect. Chinese producers and traders will export surplus steel, depressing international prices. If output falls by more than expected, the demand for raw materials will slow down, affecting prices further. In turn, that will be another bearish signal for steel prices.

Investors should keep a watch on China’s economy, as it remains the central actor in the global steel industry.

Source: Livemint