Tuesday, October 23, 2012

Steel Industry Slowdown to Persist

The global steel market is huge, valued at about $850 billion by analysts. That is not surprising considering that steel is one of the world's most widely traded commodities, with a myriad of uses. But right now, the industry is going through a rough patch. Unfortunately for investors in steel and iron ore stocks, it looks like the tough times will extend for another few years.

For investors interested in the industry, they can easily track the steel and iron ore industries through an exchange traded fund, the Market Vectors Steel ETF (NYSEMKT: SLX). Its portfolio consists entirely of steel and iron ore producing companies. Fully 60% of the fund's holdings are international stocks. The ETF is down about a third in value in the past two years.

Just several days ago, the World Steel Association (the industry's main body) lowered its forecast for global steel consumption growth this year to 2.1%, from its previous estimate of 3.6%. Last year, global steel demand was rather decent, growing at a 6.2% rate. The Association pointed to several reasons for the slowdown. These factors include slower economic growth in emerging markets, especially China, and the debt crisis in Europe.

Chinese Steel Industry Slowing

China is a huge player in the global steel market as it is both the world's biggest consumer of steel, as well as its largest producer. Many prominent international bodies including the Asian Development Bank and the World Bank have lowered their outlook for economic growth in China over the past few weeks. Even China bulls agree that Chinese economic growth is slowing the torrid double-digit pace of years past to the 6%-7% range.

The World Steel Association trimmed its forecast of Chinese steel demand this year from 4% to only 2.5%. In 2011, demand grew at a 6.4% rate. Data from China backs up the Association's forecast. Chinese steel industry profits have collapsed by 96% in the first half of 2012 compared to a year ago, according to the China Iron and Steel Association. CISA went on to describe the industry's current state as a “disaster zone”.

Weak conditions in China led the World Steel Association to predict that steel demand for all the emerging markets would only grow by 3% in 2013. Quite a slowdown from the 10% annual rate experienced over the last decade.

The news from China and elsewhere in Asia cannot be good news for a company like South Korea's POSCO ADR (NYSE: PKX). It is the world's third largest steelmaker and has a large presence throughout Asia. It is still expanding rapidly in emerging markets such as China, where the industry is in that 'disaster zone'. The company just opened an auto steel processing plant in northeastern China, for example. Its stock is down about a third in the past two years.

Eurozone Woes

At least steel demand is still growing in the developing world. Quite another story in Europe where many of the economies are expected to contract this year.

The World Steel Association now expects steel demand in Europe this year to fall by 6%. This is a sharp downward revision from its previous forecast of only a 1.2% decline. The drop-off in demand can only hurt further the European steelmakers. Many of them have already cut production and closed some facilities to reduce the chronic overcapacity in Europe's steel industry.

When one thinks of the European steel industry, one name should pop up immediately – the world's largest steelmaker, ArcelorMittal ADR (NYSE: MT). The woes of the steel industry, particularly in Europe, have pushed this once $100 a share stock down to where it is today, about $15 a share. A potential credit downgrade by Moody's and others hover over this company.

Further Fallout

In addition to the steelmakers themselves, another group will also be impacted negatively by the global steel industry's problems. That group is the companies which produce iron ore, a key component in steel making.

Prominent among the iron ore producers (and the two largest positions in SLX) are Rio Tinto PLC ADR (NYSE: RIO) and Vale S.A. ADR (NYSE: VALE), the world's biggest producer and exporter of iron ore. The problem for these firms is that their management is acting as if the economies in China, Europe and elsewhere are not slowing. The four major global iron ore producers, as projected by JPMorgan, will conservatively have 8% annual growth in iron ore production capacity. So it looks like there will be increasing supply and decreasing demand for iron ore – not good for prices and profits.

The bottom line for investors? Avoid the entire steel and iron ore sectors completely. Only re-enter them if and when global economic growth picks up steam. Look to China and other emerging economies for a clue as to when that will happen.   This article originally appeared on the Motley Fool Blog Network. Make sure to read all of my articles for the Motley Fool at http://beta.fool.com/tdalmoe/.


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