Rising commodity prices have stalled, denting sector in 2011: AKS, MT, PKX, X

At the end of 2010, steel bulls were justifiably riding high. Stocks in the sector such as AK Steel (NYSE: AKS), Arcelor Mittal (NYSE: MT), POSCO (NYSE: PKX) and U.S. Steel (NYSE: X) all had outstanding December performances sparked in large part by the bevy of price hikes in the industry. In fact, the price of a ton of the most common raw steel, hot-rolled coil, has surged about 60% from early December to mid January. That’s a very big increase.

Yet so far in 2011, steel stocks have failed to follow suit. Now investors are asking the question: where’s the strength in steel stocks? Take a look at how these four steel stocks have faired so far in 2011:

• AK Steel, -13%
• Arcelor Mittal, -7%
• PKX, -3%
• U.S. Steel, -9%

Certainly, some of the sell-off in the sector can be attributed to profit taking in these stocks after the aforementioned run up at the end of last year. However, there may be a more pernicious bear roaming about the steel plant.

Some industry observers think that the current high price steelmakers are charging customers for all types of steel is just not sustainable. In a note to clients outlining her first-quarter industry forecast, UBS Investment Research steel analyst Timma Tanners recently argued that prices for raw materials such as iron ore, coking coal and scrap used to make steel may soon “run out of steam.” That, according to Tanners, would pave the way for steel prices to level out and momentum in the sector to slow.

Tanners also said that the benchmark hot-rolled coil price in the United States is currently at $800 per ton, and is likely to stay there for the next 10 weeks. However, she added that prices will likely drop to about $700 per ton in during the second quarter. This could mean that investors are jumping the steel ship well in advance of any projected slide in the prices steelmakers can charge their customers.

The other potential reason for the lack of strength in the steel space is weak customer demand. Although sectors such as the auto industry have increased their consumption of steel, construction sector demand remains depressed. It’s this weak demand from the construction sector that may pull down steel prices going forward, and that would be widely viewed as another reason to keep selling steel stocks.

We’ll get a better sense of the industries margins, and about their projections for pricing, after all of the steelmakers report their latest quarterly earnings. Until then, or until we get a better sense of clarity on pricing and steel demand, we are likely to see more of the same weakness in steel stocks.