London, 24 October 2011

Global steel output was still robust in September, as shown by figures on Friday from the World Steel Association (WSA). That appears to bear out the message coming from raw materials suppliers such as BHP Billiton and Rio Tinto that there is a disconnect between fearful financial markets and underlying resilience in the real economy.

BHP Chief Executive Marius Kloppers told shareholders on Thursday that the company's order books were still full, while Rio Chief Executive Tom Albanese said last week that "the fundamentals are holding up well, particularly for bulk-traded commodities".

The problem, though, is the proliferation of warning signals coming from the steel sector, which leaves open the question as to how long global run-rates can hold at their current levels.

NO-ONE BLINKS IN SEPTEMBER

The WSA figures for last month contained no big surprises, good or bad. Global annualised production recovered to 1,503 million tonnes from 1,467 million tonnes in August. That was entirely in keeping with what are considered to be normal seasonal patterns. August is always a weak month for steel production because of summer holidays in the Northern Hemisphere and this year has been no different.

The August run-rate was the lowest monthly figure of 2011, just as it was last year. Nor was there much change in the global rate of year-on-year growth. September's 8.2 percent was barely changed from August's 8.3 percent. The regional divergence behind that headline figure didn't change much either.

China remained the driver of global growth, with September's production marking a 16.5 percent increase from the same month last year. True, Chinese production in annualised terms was a tad weaker at 690 million tonnes, but this is a decline from super-high run-rates of over 700 million tonnes during the second quarter.

The more recent figures from the China Iron and Steel Association (CISA), covering the first 10 days of October, showed no further decline. Production growth in the rest of the world, meanwhile, eased slightly further to 4.6 percent in September from 6.5 percent in August.

But anyone looking for dramatic changes in the European Union area, the most obvious point of weakness given the unfolding euro crisis, would have found none. Production growth in the region even picked up a notch to 4.3 percent from August's 4.2 percent. In short, global steel makers collectively held their nerve last month even as exchange-traded metals collapsed in fearful anticipation of the consequences of the continuing tragedy that is Greece.

IRON ORE ROUT

What then are the warning signals that suggest steel production may be heading for a slowdown, potentially a dramatic one? The first is the iron ore price, which is now playing catch-up with futures markets such as copper. The iron ore price has gone into freefall over the last few days. The spot price for 62 percent iron content ore, basis the Platts index , fell to $145 per tonne yesterday, its lowest level in a year.

The Singapore swaps market suggests no imminent recovery as forward months move into steep discount to the spot contract. The sheer speed of the price slide has become self-feeding as Chinese buyers, the key determinants of spot price assessments, stay on the sidelines until the price shows signs of bottoming.

In principle falling iron ore prices should take some of the margin pressure off Chinese steel mills. The problem is that Chinese steel prices are also falling fast. Shanghai rebar futures prices slumped to contract lows this week, with local traders pointing to weakening demand and accumulating stocks.

If these are true signals, rather than just contagious financial market panic, the outlook for Chinese steel production has suddenly and sharply deteriorated.

LOOK FORWARD, LOOK BACK

Given that China is the current driver of global steel production growth, the impact of any slowdown there is hard to overstate. Production growth outside of China has been topping out in a 4-5 percent range over the past four months. And it seems highly unlikely that it is going to pick up any time soon, particularly since financial uncertainty in Europe is now really starting to feed into steel production.

ArcelorMittal confirmed on Friday it will temporarily close a blast furnace in Poland. This adds to a lengthening list of European shutdowns by the world's largest steel producer, which warned that the latest closure follows an analysis of "order intake for the coming months".

Finnish specialist steelmaker Rautaruukki has also just highlighted deteriorating demand, most visibly in direct mill deliveries to major steel consumers. Fellow Finnish stainless steel producer Outokumpu flagged up a decline in fourth-quarter deliveries, again citing "weakened demand".

The accumulation of outlook downgrades as the Q3 reporting season picks up momentum is a worrying sign of things to come. Steel production, remember, is a lagging indicator, and the monthly WSA figures are themselves "look-back" in nature. Just how lagging we may be about to find out very soon.

Ends --

By Andy Home, Reuters market analyst – for Commodities Now with permission.

The views expressed here are his own.