Got Your Eye on Steel?

If you are eyeing a steel company these days, you may want to read what I have to say. It could save you some headaches and some capital down the road. Steel stocks have had a strong run- up, but I believe the easy money has already been made. Note this and look elsewhere for trading opportunities.

 Steel stocks like AK Steel Holding Corp. (NYSE/AKS), U.S. Steel Corp. (NYSE/X), and Nucor Corp. (NYSE/NUE) all appear to be cheap, trading at less than 10 times trailing and forward earnings. So why my sad face?

 Here’s what I believe. Inventory levels for steel products are rising, and demand is looking flat. You don’t have to be an economics major to conclude that excess supply coupled with lower demand implies lower steel prices. It’s that simple. But that’s not all.

 I keep on hearing about the surging demand and insatiable appetite for steel from China, one of the biggest users of steel in the world. It may be true that it is a major user of steel and this consumption drives the building boom that is occurring across the ocean… but guess what? China doesn’t need our steel or any other foreign steel either. Just last year, China was a net importer of steel, but the country has since made a U-turn. Now a net exporter of steel, China is rapidly producing its own steel at extremely low costs.

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 Steel production in China is limitless, which concerns the world steel market, since China can now produce plenty of steel for its export market.

 Just take a look at these statistics: Chinese steel production has increased in four consecutive months from February to May of this year. Chinese steel production in May was a record at nearly 30 million tons. The increase has been rapid. In May 2004, Chinese steel production was just over 20 million tons. China is also rapidly increasing its steel production capacity today, and some pundits believe another 40 million tons of capacity will be added this year. That is a lot of steel!

 A report was recently produced by Merrill Lynch that said the belief that exports from China would flood the market with ample surpluses and drive prices lower was misplaced.

 But whether you believe Merrill Lynch or not is entirely up to you. Personally, I believe there is a real concern about excess production surfacing out of China and driving down prices.

 Don’t forget, steel is a commodity that can be produced easily. So before you jump on that cheap steel stock, you may just want to take a step back and look across the Pacific to China.