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Apr 3, 2017

S3 BLACKLIGHT: Steel Sector Short Interest Recap – March 2017

The Steel Industry is at an inflection point where the world’s largest producer and consumer of steel, China, has mandated an industry-wide reduction in steel production by 50 million metric tons and is closing down 150 million metric tons of outdated steel production capacities. With China’s 2016 steel production at 808 million metric tons, this represents a 6% reduction in production and an 18% reduction in capacity. While China is struggling with overcapacity and underutilization issues, the fourth largest steel producer, the U.S., is standing on the cusp of a $1 trillion infrastructure initiative that would boost domestic production and consumption.

With a glut of iron ore in Chinese ports and the Chinese government looking to avert a plunge in iron ore prices, which would result in another blow to its manufacturing sector and unemployment figures, there is a genuine downside risk to stock prices in the Asian steel sector. Unfortunately, the ability to short the largest Chinese steel producers is limited because the companies, such a Heibei, Baosteel and Jiangsu Shagong, are either state owned, privately owned or unshortable A shares.

That is not to say that short sellers are staying away from the steel sector. Total short interest at the end of March increased to $9.3 billion up $704 million, or 8%, for the month. If iron ore prices decline significantly from recent highs and steel demand does not rebound to soak up excess production, we may see a glut of cheap steel forcing stock prices down even further.
Short interest in the steel sector is very consolidated, with the top ten shorts making up 82% of all short interest.

Eight out of the top ten increases in short interest were international companies, five of which in the Asian region.

Steel sector short sellers did not do well in 2016 with the top ten most profitable securities only up $90 million, but the top ten least profitable securities down $3.1 billion.

Shorting steel stocks in 2017 has shown better results than in 2016, but was still a losing proposition for most of the steel sector’s constituents. The top ten most profitable shorted stocks were up $251 million while the top ten least profitable shorted stocks were down $513 million.

Analysts are predicting a drop in worldwide steel production in 2017 based on China’s mandated reductions, but an increase in worldwide demand based primarily on improving employment levels, a more robust housing sector and increased infrastructure projects in the U.S. Even though the projected increase in U.S. steel consumption will empirically boost worldwide demand, there is a chance that the demand will be satisfied mostly by domestic production and worldwide producers will not be partaking in the increased consumption. If U.S. steel producers like Nucor Corp, U.S. Steel, AK Steel Corp and Steel Dynamics get the lion’s share of new domestic steel demand at the expense of ArcelorMittal, Baosteel, POSCO and Nippon Steel, then short interest levels will look dramatically different by the end of 2017.

Want deeper insight into the above analysis? Contact:
Head of Research, S3 Partners
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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