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Steel Stocks: How to Play This Bearish Moment

NEW YORK ( TheStreet) -- Steel stocks have entered a decidedly bearish moment as the global economic recovery comes into doubt.

Whether you're already a shareholder or looking to take a fresh position now, given that stock prices in the sector have declined more than 30% from their April peak, here's what you need to pay attention to for the rest of the year:


The Past: By now, every investor is familiar with "The China Story," as the financial world has come to call it. It goes a little something like this: Breakneck economic growth followed by worries in Beijing about inflating asset bubbles, followed by de facto credit tightening to reduce the risk of those bubbles, followed by terror that the world's highest-flying economy would stall out with a so-called "hard landing."

Steel production in China hasn't slowed, not yet anyway. The nation's furnaces, which produce nearly as much steel as the rest of the world combined, achieved record output again in May, producing more than 56 million metric tons of the stuff. Those numbers would seem to defy the notion that the country had eased back on its growth throttles, a notion that has since March put pressure on prices of commodities as well as metals stocks.

The Present: This week, China's publicly stated intention to allow the yuan (eventually) to run free sparked a brief uptick in the shares of steelmakers based elsewhere in the world.

That's because a stronger yuan would, in theory, discourage Chinese steel exports, reducing the risk of a flooded global market and boosting the competitive advantage of U.S.-based companies. But China's currency promises are, at the moment, just that: promises. And any real economic impact on steelmakers stateside won't be felt for a long time to come.

The Future: For steel equities, the bigger story involves China's plans for production. Recent signals from the People's Republic suggest that the country's mills now intend to cut back on production, and soon. That's because steelmakers there are getting whacked by higher raw materials costs -- far more than their U.S. counterparts. At the same time, global steel prices have gone into decline of late, falling by as much as 10%. To staunch the narrowing of their profit margins, Chinese steelmakers almost have no choice but to calm the blast furnaces (which were first invented in China, by the way, in the fifth century B.C.).

Furthermore, Beijing recently announced plans to reduce carbon emissions by eventually pulling the plug on a good number of the country's older, dirtier, less-efficient mills. The environmental moves could remove as much as 8% of China's overall annual capacity, which stands at 600 million metric tons.

What does this mean for domestic steelmakers like U.S. Steel (X - Get Report) and Nucor (NUE - Get Report)? Because China has become such a dominant force in the global steel industry, its prices have become the world's prices. Any crimping of creeping supply will thus benefit everyone.

In the end, investors ought to keep an eye on the monthly steel-production dispatches coming from Beijing.
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