>STEEL PICTURE BOOK (CITI)

■ Prices Rising in All Regions — Carbon steel prices are slowly moving higher as the arbitrage gaps between US/European and China prices close, and raw material prices increase. We believe there is additional upside potential for steelmaking raw materials as the northern hemisphere summer starts (with the concomitant seasonal construction increase). In our selection we prefer raw material-integrated and spot price-focused steel producers.

■ China Cost Position Deteriorates — Higher raw material costs are leading to higher proportionate costs for China, as raw material costs are US$-based and the renminbi is pegged. We believe the short-term demand outlook for China is supportive and cost pressures and lack of raw material access will moderate the impact of any potential future slowdown on other steel-producing regions.

China Strength Feeding through to Raw Materials

■ OECD Restocking to Accelerate — Inventory restocking slowed in December, as consumers protected fragile balance sheets and kept working capital levels low. We anticipate a re-acceleration of the restocking process as price momentum improves and seasonal demand lifts in 1H2010.

■ Operating Rates Recovering — Global steel production has recovered, with production reaching 107.5mt in November (+22.4% YoY, but -4.2% MoM) and operating rates at 77% also significantly better than 69.8% in November 2008. Asia posted another strong production month in November (66.8mt, +23.5%). and now constitutes >62% of global production.

■ China: Raw Materials — Iron ore import volumes for November were 51.07mt (+12.3% MoM). Domestic iron ore production was another monthly record at 86.78mt (+4.1% MoM and +19.4% YoY). Coking coal imports of 2.9mt were 29.4% up MoM, and export volumes were at 74.7kt compared to 129.1kt in October.

■ Short-Term Positives Increase — Restocking activity is modest, but supportive of demand in the near term, and raw material price settlements are expected to support steel prices (the key driver of shares) into 2010e. Although the short term outlook looks positive, we have not turned structural bulls due to the high levels of excess capacity in the system. We remain selective on our outlook for steel companies, and cautious on the full year outlook for 2010. We prefer companies with raw material integration and spot price focus in the near-term.

To read the full report: STEEL PICTURE BOOK