UBS Investment Research reports on the "warning factors for global steel markets after a strong run in pricing and raw materials. We see signs that both may be ripe for at least a pause, as markets digest the big run, but see potential for a price correction after a strong restocking in China of both finished steel and iron ore. We think investors should not ignore the global impact of China having bought more raw materials and produced more steel than underlying consumption would have dictated. This, in turn, can end some of the cost pressure on steel prices and help the market retreat.

Our China analyst Hubert Tang thinks the restocking in China has nearly run its course, after a 42% rise in the trader inventory tabulated at 23 main Chinese cities over the past two months. China’s restocking was larger than normal because it followed sharp destocking in Q4 as a result of energy efficiency measures enforced in the last four months of 2010 in order for the Chinese government to meet targeted levels as of the end of its last five-year plan. We think this restocking contributed to tight raw materials markets from November.

Even if iron ore and scrap prices retreat from peaks, as we expect, we think many steel mills will feel cost hikes into H2 on the lag effect of cost increases from seaborne spot suppliers. This can squeeze margins and or limit pricing pressure into H2, in our view.

Much of the northern hemisphere was hit by harsh winter conditions of late, and in the U.S. in particular steel markets were constrained by slow rail traffic, production interruptions, and scrap procurement challenges. Already we are seeing evidence of some of this improving, and we understand that four U.S. mills (Severstal Dearborn, U.S. Steel Granite City, Algoma #7, and ArcelorMittal’s Indiana Harbor #3) have just restarted or are in the process of restarting. Some European capacity has also restarted. Scrap has begun to “flow” more normally, and the market into March looks to continue to be giving back January’s sharp more than $70/t price hike.

Seasonally demand is strongest in much of the world in Q1 and Q2, and as lead times extend into April/May, the market is quickly approaching normal seasonal strength. In addition to the normal strength, we believe steel buyers were buying more tons than needed in order to preempt a rapidly rising steel price environment. That should have begun to abate in recent weeks, and contacts tell us that business above $800/short ton has slowed. Turkish scrap buyers also got more price sensitive of late, and switched traditional U.S.-based imports to the European and Asian market.

In addition to iron ore and steel prices in China beginning to abate, we hear that import offers into the U.S. have stepped up. Indian mills reportedly were more interested in export business of late. We’re told Russian mills dropped their export price by $50/t for March production. Steel Market Update publisher John Packard told us that manufacturers were more keen to pursue import than in the past and than distributors. On the margin more distributors in his latest survey were planning to destock inventory. Also, more buyers were seeing lead times shrink as of mid-February than in his survey from the start of the year. U.S. lead times in general were still 6-8 weeks for mini-mills, but were longer for integrated mills, many of whom have been well behind schedule. We hear mini-mills and some distributors are picking up business from customers double ordering to fill inventory holes because integrated deliveries are so behind.

Recent market strength looks inflated by several seasonal factors, particularly unsustained weather and unsustained restocking. Markets where prices have risen the most, specifically the U.S. and Europe, are most vulnerable for a correction we think, whereas other Asian markets that have particularly lagged can be steadier. Chinese prices up 16% since late October compare with the U.S. up 64%. We prefer specialty/higher value-add names such as Baosteel, ATI, and ThyssenKrupp, which we think can fare better than more price levered AK Steel, U.S. Steel, ArcelorMittal, and Salzgitter."