Why Steel Stocks and ETFs Will Stay Weak in 2012

September 26, 2012 /

Steelmaker shares tumbled Tuesday as construction and mining equipment makerCaterpillar ( CAT ) cut its 2015 profit outlook owing to global economic weakness.

Analysts have a dismal outlook for the industry for the remainder of the year despite China’s stealth building plans and global central banks printing money.

Market Vectors Steel ETF ( SLX ), a basket of 27 global steel producers, dropped 2.08%. Its shares have declined for seven days straight after failing to hold above the key 200-day average that it briefly popped above following the quantitative easing announcement Sept. 13. SLX is down 4% year to date while up 5.3% the past 12 months. That’s a dismal performance compared to the S&P 500′s 18% and 31% rally over the same periods.

Iron ore prices crashed from $128 a ton in July to as low as $90 in September, Patricia Mohr noted in her latest ScotiaBank Commodity Price Index report. They’ve crashed nearly 50% from a high of $187 a ton in February 2011.

“Chinese steel mills have been working down high iron ore inventories, given the slowdown in demand for construction-grade steel,” Mohr wrote. “Iron ore inventories have likely fallen from 30 days several months ago to 10-20 days.”

Prices bounced back to $105 in mid-September, thanks to seasonal demand in the fall and China announcing an aggressive infrastructure building program. The sharp drop in prices have prompted some companies to put off development in Western Australia and may lead to more mergers and acquisitions, she added.

Stainless steel, the biggest commodity loser in third quarter, fell 12% in the three months ending September. The usual culprit — slowing growth and excess supply in China.

“The Chinese steel industry is hyper-competitive, pushing finished steel prices down to cost,” said Paul Robinson, senior economist at market research firm IHS in Washington D.C.

“As long as China, with nearly half of the world’s steel production, is hovering at cost, the rest of the world will struggle to push beyond those levels. Furthermore, weakening end-market demand in China has led to falling steel production there, which led to falling raw material prices, which only pushed finished steel prices lower.”

Steel remains oversupplied globally and U.S. steel companies see further weakness for the rest of 2012, Credit Suisse wrote in a client note Monday.

“Steelmakers expect continued near-term weakness to result in further capacity closures, while buyers have adopted a ‘wait-and-see’ approach to their buying patterns, causing further risk to steel prices,” Credit Suisse analysts wrote. “The U.S. continues to be their most profitable market, reflecting a relatively disciplined supply side and stable demand, although imports pose the biggest risk to prices in the near-term.”

China’s massive infrastructure building program and global quantitative easing has failed to support prices.
“It is really a case of ‘been there, done that,’” said Patrick O’Hare, chief market analyst for Briefing.com. “We have experienced QE1 and QE2, long-term refinancing operations by the European Central Bank, and a large stimulus plan from China already, and yet here we are with gross domestic product growth waning in each of those economic zones.”

“The market is perhaps beginning to recognize that the Federal Reserve, and other central banks, can maintain the status ‘woe’ of subpar growth with their monetary policy, but that other factors — such as tight credit conditions and household deleveraging — are getting in the way of achieving escape velocity that would invite above-average growth,” O’Hare added.

Steel Dynamics ( STLD ), down 3.49% Tuesday, will pass out a 10-cents-a-share dividend Wednesday. It’s been trading below both its 50- and 200-day moving averages for nearly two months, which is very bearish. Sales and earnings fell the past two quarters straight. Jefferies downgraded the stock to hold from buy last week.

“Still a favorite within the steel mill group and undervalued on expected earnings power in a full recovery scenario, we expect Steel Dynamic’s greater flat rolled exposure, higher recycling participation and higher beta (relative to more defensive peer Nucor and the distributors) will be head winds for the shares relative to the group near term,” Jefferies’ equity analysts wrote in a client note.

Nucor ( NUE ), down 2.07%, said it expects poor third-quarter results. It sees earnings diving 39% to 47% from 57 cents a share in the year-ago period to 30 cents to 35 cents. It lost money buying Skyline Steel and on its sale of Nucor Wire Products Pennsylvania.

“Nucor expects lower profitability at its steel mills due to continued increase in steel imports and the sluggish economy,” Zacks Equity Research reported last Wednesday. “Meanwhile, volatility in scrap prices, along with a combination of political and economic uncertainty, has also disrupted supply stocking levels.”
Citigroup cutUnited States Steel ( X ), off 1.33%, to neutral andAK Steel (AKS), down 2.2%, to sell Monday after lowering its steel price forecasts.


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