Sector Update: Steel

Sector Update: Steel

China has again turned to be a net steel exporter from being a net steel importer. This is a potential threat for the global steel industry, as China is seen as one of the key demand drivers for the steel industry globally.

Moreover, Chinese steel price has begun to fall over the past few weeks after rising by 13% in the last two months.

At the current run rate China is expected to produce more than 600 million tonne of steel in 2009, which is above the government’s target of 460 million tonne. Currently, China has capacity to produce 660 million tonne of steel per year, resulting in an overcapacity of 190 million tonne given the local demand at 470 million tonne.

Chinese ministry is drafting guidelines for mergers and acquisition in the steel industry, as it believes the overcapacity in steel sector to be the most serious issue among all the sectors of the economy.

According to reports, in a bid to curb overcapacity the government will freeze approvals of new steel projects for the next three years.

We believe, capacity curtailment is necessary for the steel industry, as China is now expected to increase its market share in the export market.

For July 2009 China has reported an iron ore import of 58.1 million metric tonne, a rise of 5% or $4.29 billion from June 2009, whereas the iron ore port inventory touched 75 million tonne, a rise of 4% month on month.

Since iron ore imports are high in July, steel production will continue with growth in August, however the increasing inventory level does carry a risk of fall in steel prices.


Our sense is that the current valuation enjoyed by metal stocks is demanding and is mainly backed on the hope of a sharp V-shaped recovery in China, which we feel has been due to massive government spending. (money supply growth in China is now at 28%, the highest in the last 10 years—see the chart above).

We believe, business cycle upswings are essential to cause a long term re-rating than an inventory adjustment cycle, which the sector is currently going through. Hence we believe the demand could weaken once the inventory adjustments are completed.

We have a cautious outlook on the sector. Moreover, after the steep run-up and given the uncertain business environment, the risk-reward remains unfavourable.