Steel prices are reaching all-time highs. Steel Stocks are breaking 2008 highs. This is what’s happening in the sector & what makes us cautious.

Why is Steel important?

Steel is the world’s 2nd-largest commodity after crude oil. It is 15 times the size of all other metals markets combined in terms of tons and it is worth twice its value. It is used in the production of our roads, bridges, houses, automobiles, etc.

Steel is a global commodity that has similar pricing all over the world due to low transport cost compared to its value. However, it is not the global supply & demand dynamics that rule its pricing.

The China Factor

It’s China’s supply & demand. As of 2020, China boasts over 55% of the global Steel capacity. Adding that, China is also the largest consumer of steel with gobbling up nearly 900MT in the recent year.

Thus, China is both the largest global steel consumer and the largest global steel producer by a large margin, and the balance between its domestic production and consumption has been an important factor influencing global steel prices.

It can be observed that China’s net exports have a significantly high (which are a result of either slowing down of the domestic economy or oversaturation concerning usage of steel) and inverse correlation to international steel price.

Why is China so ahead of us?

They have a huge cost advantage due to huge economies of scale, easy RM availability, government support in terms of export rebates up to a mind-boggling 13% of sales (leading to a price lower than the cost of production of competitors), etc.

Fun fact: Indian steel makers survive just due to protectionism by our government in terms of safeguard duties & anti-dumping duties.

To delve deeper into what has been the tailwinds to the sector, below mentioned is a steelmaking process

One can notice, Iron ore is the primary raw material used to produce steel. The whole rally in steel started due to the Iron Ore supply shocks.

Iron ore was the best performing commodity in 2020, thanks to China’s early emergence from the pandemic and Beijing’s heavy spending on economic stimulus, particularly infrastructure.

This was mixed with supply shocks across the globe as the miners faced the COVID crisis following the collapse of the Brumadinho dam owned by Vale in Brazil and a heavy cyclone season in Australia An increase in demand just when the Supply is down is where the magic happens.

How long will it last?

Brazilian output is expected to recover to normal levels by the end of 2021. Moreover, with Australia’s weather back on the line, This will put notable downward pressure on steel prices as they would pass on the benefits to the end-consumer industries.

Is it a commodity supercycle or the music is dampening?

For this, One should look into the end products. Would you buy the same car at a 40% premium to a year ago’s price? Most probably, No.

Well, that’s your answer. These companies can’t keep on increasing prices after a point.

As these prices in turn impact construction, the auto sector, and other key manufacturing industries that are the pistons driving the global economy. Sanity prevails over time.

China’s shenanigans will never stop.

+ It’s a given that in the long-term, Chinese steel demand is expected to decline, as the economy slows, the need for large infrastructure projects wanes, and the pace of urbanization moderates.

Take the example of the USA

Demand is down from 140MT to 80MT in the last 5 decades as their demand for steel reached saturation.

This is the world’s most prosperous country. The overcapacity doesn’t bode well for steel globally in the long term.

Your guess is as good as ours in the short term.

Additionally, the valuations of the Indian steel companies are near their past cyclical highs according to the historical data.

As structurally nothing seems to have changed, we are not going to pay up.

Postscript: A wise man once said, “The skill in attending the party is knowing when it’s time to leave.”

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