Since late October last year, the main contract of steel futures has rebounded from the bottom, showing a slight upward trend after consolidation. Before and after the Spring Festival, with the improvement of spring start-up expectations, the restocking trend strengthened the spot market. However, overall, the downturn in the steel industry is unlikely to change in the short term, and there are no obvious signs yet of a shift in the low-profit status of the entire industry. Currently, the fundamentals of steel are in a weak balance due to reduced production and sluggish demand.
From a macro perspective, the market's focus has shifted from the European debt crisis abroad to the policy direction of the National People's Congress at home. The continuous escalation of Greece's debt problems did not cause market panic; instead, the market reacted numbly to the constant increase in Greek bond yields and downgrades in ratings. In contrast, positive reactions were seen for favorable U.S. macro data such as consumer confidence index, employment, and housing starts. However, the strong market performance came to an abrupt halt following the Central Government's announcement of a lower economic growth target for 2012 during the National People’s Congress session. The slowdown in infrastructure construction and the continuation of real estate regulation have become the greatest pressures on commodity prices.
Observing the steel industry itself, the long-term cycle of declining profit margins has not ended, and the industry is currently in a critical adjustment period. Whether it is the reorganization and transformation of steel mills themselves or the reshuffling in the steel trading sector, the optimization of resource allocation has accelerated. After funds flowed out of steel trading companies seeking profit points, Wugang Group’s move into pig farming reflects the reluctant transformation strategy of steel enterprises. Among the 24 stocks in A-shares that broke below net asset value, 10 were steel stocks, and 70% of the top 10 were steel stocks. According to statistics from the China Iron and Steel Association, among the 29 enterprises producing over 5 million tons of steel in January 2012, 12 were loss-making, with a loss-making ratio of 41.38%. After offsetting profits and losses, the net loss was 2.177 billion yuan, and the average sales profit margin further declined to -0.89%. The steel industry undoubtedly finds itself in another industry low point. But we should also see that the duration of industry-wide losses will not be too long, similar to the full industry losses in early 2009. With the release of demand, the rise in price and profit is only natural.
The improvement of the industry awaits adjustments in the medium to long term, but in the short term, the steel market has greatly improved compared to November last year due to reduced steel mill production and warming transactions. Since late October last year, the sharp drop in steel prices has led to passive production cuts by steel mills. The daily domestic crude steel output has been maintained within the range of 1.6 million to 1.7 million tons for nearly four months, which is the lowest level since 2011. With the decline in steel prices, steel mills have shifted from earlier passive production cuts to current active maintenance and shutdowns, and daily output will remain low in the short term.
Demand continues to show weakness. From real estate, railways, shipbuilding, automobiles, and home appliances, there are few bright spots to be found. The investment growth rate of water conservancy projects might be the only noteworthy aspect of fixed-asset investment, but its impact on steel demand still needs observation. The much-anticipated lifeline for steel demand this year still lies in affordable housing construction. At the National People's Congress, Premier Wen Jiabao reiterated the 2012 task for affordable housing construction: start more than 7 million units and complete at least 5 million units. We estimate that new projects plus carry-over projects from the previous two years will bring the total number of ongoing affordable housing projects in 2012 to about 16 million units, with a construction area reaching 880 million square meters, accounting for 17%-20% of the total annual building construction area. The uncertainty in achieving these goals still lies in the implementation of funding.
In the rebar futures market, the position situation has changed significantly recently: first, the short side actively adds positions when prices rise, and the main shorts are highly concentrated; second, the Shagang seat has re-entered to participate in selling hedging. These changes bring positive significance to the evolution of the steel futures market, first making transactions more active and increasing market attention. Gradually rising futures prices provide good market conditions for selling hedging, as evidenced by the entry of the Shagang seat. I boldly speculate that among the main shorts, there may be hedging short orders entered earlier by steel enterprises. The participation of steel enterprises undoubtedly optimizes the investor structure of steel futures. Once the market moves, a stable counterparty will also help the continuity of the market trend.
In summary, the melancholy atmosphere of the steel industry will ease with the improvement in demand. The weak balance of supply and demand waiting for a breakthrough hinges on whether monetary policy can loosen up. Once under-construction and planned projects start, there exists a potential for a phased upward trend in steel futures.
(The author is an analyst at Guotai Junan Futures (Weibo))