Steel Industry Slowdown Lingering

Tony is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The global steel market is huge, valued at about $850 billion by analysts. That is not surprising, considering that steel is one of the world's most widely traded commodities, with a myriad of uses. But right now, the industry is going through a rough patch. Unfortunately for investors in steel and iron ore stocks, it looks like the tough times will extend for another few years. 

Interested investors can easily track the steel and iron ore industries through an exchange-traded fund, the Market Vectors Steel ETF (NYSEMKT: SLX). Its portfolio consists entirely of steel- and iron ore-producing companies. Fully 60% of the fund's holdings are international stocks. The ETF is down about a third in value in the past two years.  

Several days ago, the World Steel Association (the industry's main body) lowered its forecast for global steel consumption growth this year to 2.1%, from its previous estimate of 3.6%. Last year, global steel demand was rather decent, growing at a 6.2% rate. The Association pointed to several reasons for the slowdown. These factors include slower economic growth in emerging markets, especially China, and the debt crisis in Europe. 

Chinese steel industry slowing
China is a huge player in the global steel market, as it is both the world's biggest consumer of steel and its largest producer. Many prominent international bodies including the Asian Development Bank and the World Bank have lowered their outlook for economic growth in China over the past few weeks. Even China bulls agree that Chinese economic growth is slowing the torrid double-digit pace of years past to the 6%-7% range. 

The World Steel Association trimmed its forecast of Chinese steel demand this year from 4% to only 2.5%. In 2011, demand grew at a 6.4% rate. Data from China backs up the association's forecast. Chinese steel industry profits have collapsed by 96% in the first half of 2012 compared to a year ago, according to the China Iron and Steel Association. CISA went on to describe the industry's current state as a “disaster zone”. 

Weak conditions in China led the World Steel Association to predict that steel demand for all the emerging markets would only grow by 3% in 2013. Quite a slowdown from the 10% annual rate experienced over the last decade. 

The news from China and elsewhere in Asia cannot be good news for a company like South Korea's POSCO ADR (NYSE: PKX). It is the world's third-largest steelmaker and has a large presence throughout Asia. It is still expanding rapidly in emerging markets such as China, including a newly opened auto steel processing plant in the northeast of that country. POSCO's stock is down about a third in the past two years. 

Eurozone woes
At least steel demand is still growing in the developing world. Europe, where many economies are expected to contract this year, tells quite a different story. 

The World Steel Association now expects steel demand in Europe this year to fall by 6%. This is a sharp downward revision from its previous forecast of only a 1.2% decline. The drop-off in demand can only hurt further the European steelmakers. Many of them have already cut production and closed some facilities to reduce the chronic overcapacity in Europe's steel industry. 

When one thinks of the European steel industry, one name should pop up immediately – the world's largest steelmaker, ArcelorMittal (NYSE: MT). The woes of the steel industry, particularly in Europe, have pushed this once $100-a-share stock down to about $15 a share today. A potential credit downgrade by Moody's and others hover over this company. 

Further fallout
In addition to the steelmakers themselves, another group will also be hurt by the global steel industry's problems: Producers of iron ore, a key component in steelmaking. 

Prominent among the iron ore producers (and the two largest positions in SLX) are Rio Tinto PLC (NYSE: RIO) and Vale S.A. (NYSE: VALE), the world's biggest producer and exporter of iron ore. The problem for these firms is that their management is acting as if the economies in China, Europe, and elsewhere are not slowing. The four major global iron ore producers, as projected by JPMorgan, will conservatively have 8% annual growth in iron ore production capacity. So it looks like there will be increasing supply and decreasing demand for iron ore – not good for prices and profits.  

The bottom line for investors? Avoid the entire steel and iron ore sectors completely. Only re-enter them if and when global economic growth picks up steam. Look to China and other emerging economies for a clue as to when that will happen.

tdalmoe has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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