Steel, a leading indicator on the economy, could be turning negative

09/14/2009 10:38 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Steel goes into buildings, appliances, and cars. That makes demand for steel a leading indicator for the economy since companies order steel in antipication of rising sales of their own products.

This summer global demand moved up and so did prices. In  August a metric ton of hot-rolled  steel went for $600 to $620 a ton. Rising steel prices on rising demand provided a sign that the global economy was headed for recovery.

Now prices have dropped back to $570 a ton, according to World Steel Dynamics.

Does that mean that we're headed back towards recession again?

What's clear is that demand hasn't grown as fast as steel makers ancipated. Looking at stimulus plans from Beijing to Berlin, steel makers from ArcelorMittal (MT), the world's largest steel maker to Baosteel Group, China's largest steel maker, fired up idled mills.

ArcelorMittal, for example, had cut production by about 30% in 2008. But in 2009 the company and much of the rest of the global industry have been restarting some of their mills.

Too much capacity went back into production too fast--and steel prices are now correcting to reflect that.

What's not so clear is whether the recent drop in steel prices is just a temporary pause while demand catches up to supply or a sign that much of the demand for steel this year wasn't a sign of economic recovery but simply temporary restocking by companies that had drawn down inventory.

This isn't a new question for the global economy. The jury is still out about how sustained the pickup in demand for commodities from iron ore to copper to steel really is.

In a sustained economic downturn like one that may now be ending companies typically put off re-ordering raw materials and restocking their shelves. Instead they use up or sell what they have in hand in their inventories and only reorder when those inventories are depleted.

Sometimes--usually in relatively mild recesssions--this inventory restocking is itself enough to get the economy going again.

In a deep recession like this one, though, companies that have restocked may decide to drawn down their inventories again rather than risking a return to normal ordering patterns and normal high levels of inventory.

The risk of running out of raw materials or stuff to sell is less than the risk of getting stuck with hugh piles of raw materials or consumer goods that just sit there gathering dust and eating away at the bottom line.

In that case instead of steadily rising demand the economy sees a series of starts and stops that keep it sputtering but that aren't enough to make the engine turnover and catch fire.

Watch steel prices (and the price for iron ore, the key raw material for steel makers) to see whether economic demand is indeed picking up--in which cases prices should rebound from their recent decline--or whether we're headed for a dip back towards recession.

Nobody ever said these weren't interesting times for the global economy.

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