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 resumption expectations, the restocking trend boosted the spot market. However, overall, the decline in the steel industry is unlikely to change in the short term. There are no obvious signs yet of a shift in the low-profit status of the industry as a whole. Currently, the basic situation of steel fundamentals is in a weak balance with reduced output and lackluster demand.
From a macro perspective, the market's focus has shifted from Europe's debt crisis abroad to domestic policy guidance during the Two Sessions. The continuous escalation of Greece's debt issues did not cause market panic; instead, the market reacted positively to favorable U.S. macroeconomic data such as consumer confidence index, employment, and housing starts. However, the strong market performance came to an abrupt end after the central government lowered the 2012 economic growth target at the beginning of the Two Sessions. The slowdown in infrastructure construction and the continuation of real estate regulation have become the biggest pressures on commodity prices.
Observing the steel industry itself, the long-term cycle of declining profit margins has not ended yet. 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 the outflow of funds from steel trading enterprises seeking profit points, Wugang's "pig farming" reflects the helpless transformation strategy of steel companies. Among the 24 stocks in A-share that broke below net asset value, 10 were steel stocks, accounting for 70% of the top ten. 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 rate of 41.38%. After offsetting profits and losses, there was a net loss of 2.177 billion yuan, and the average sales profit margin further declined to -0.89%. The steel industry undoubtedly finds itself again in an industry trough. However, we should also see that the duration of industry-wide losses will not be too long. Just like the industry-wide losses in early 2009, with the release of demand, the rise in price and profit will naturally follow.
Industry improvement awaits medium- to long-term adjustments, but in the short term, with steel mills reducing production and transactions warming up, the pessimistic atmosphere of the industry has greatly improved compared to November last year. Since late October last year, the sharp drop in steel prices has forced steel mills to reduce production passively. Domestic daily crude steel output has remained in 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 passive reduction in production to active maintenance shutdowns, and daily output will likely remain low in the short term.
Demand continues to maintain a weak trend. Looking at various aspects such as real estate, railways, shipbuilding, automobiles, and home appliances, there are few bright spots to be found. The investment growth rate in water conservancy projects may be the only notable aspect in fixed asset investments, but its impact on steel demand still needs to be observed. The only hope for the entire year's steel demand lies in the construction of affordable housing. During the Two Sessions, Premier Wen reiterated the 2012 task for affordable housing construction: start more than 7 million units, and complete at least 5 million units. We estimate that newly started projects plus carry-over projects from the previous two years will bring the total scale of affordable housing under construction in 2012 to about 16 million units, with an estimated construction area reaching 880 million square meters, accounting for 17%-20% of the total building construction area for the year. The uncertainty in achieving these goals lies in the implementation of funding.
In the rebar futures market, recent changes in holding positions have been significant: firstly, short sellers actively added positions when prices were high, and major short players are very concentrated; secondly, the Shagang seat re-entered the market to participate in selling hedging. These changes bring positive implications to the evolution of steel futures trends: first, trading becomes more active, increasing market attention; second, rising futures prices provide good market conditions for selling hedging, which has already been reflected by the entry of the Shagang seat. I boldly speculate that among the major short players, there might be hedging shorts entered earlier by steel companies. The participation of steel companies undoubtedly optimizes the investor structure of steel futures. Once the market moves, a stable counterparty will help sustain the market trend.
In summary, the sorrowful atmosphere in the steel industry will ease with improving demand. The weak balance of supply and demand awaits breakthroughs. The key point lies in whether there can be some relaxation in monetary policy. Once ongoing and planned projects start, there will be a stage-wise upward trend in steel futures.
(The author is an analyst at Guotai Junan Futures (Weibo))