Nerds of Steel

Until a few years ago the steel industry was considered mature, and the moniker was accurate. Global steel demand grew more slowly than did the world’s population. In much of the developed world, demand for steel was stagnant after having gone through a long period of decline. Since 1998, however, the steel industry seems to have re-ignited its growth engine and kicked into a new gear. The industry has been growing at 6% annually and most analysts see strong growth continuing for a decade or more. What explains the steel industry’s reemergence and can it continue?

Although there are a number of underlying drivers which explain the renewed vigor of the industry, the simplest explanation is GDP growth. After growing by an average of 3.5% for almost 3 decades, global GDP growth averaged 5% from 2004 through 2007. This increase in the global growth rate has had a very positive effect on the demand for steel and other commodities.

World GDP Growth 1975 to 2007

Sources: IMF, Angus Maddison

So, what explains the increase in global growth rates and how does increased GDP growth translate into greater steel demand? While there are a number of factors at work, a few graphs illustrate the point fairly well. First, for a variety of reasons, emerging economies grow faster than developed economies. While this has been true for a long time, the difference has become more pronounced recently, as the large populations of the BRIC countries have emerged as economic powers.

GDP Growth Rates: Developed vs. Emerging Economies

Source: IMF World Economic Outlook

The rapid growth and sheer size of the BRIC economies has been shifting the balance of global economic power. From 40% in the mid 1990s, the faster growing emerging economies now account for close to 50% of global output.

Developing Economies’ Share of Global GDP

Source: IMF World Economic Outlook

With 50% of the world growing at over 7% per year, the global economy has a strong wind at its back. This explains the rise in global GDP growth from 3.5% to 5% annually. But is this enough of a change to explain the re-emergence of steel as a global growth industry? We think it is.

Not surprisingly, steel demand and GDP growth are positively correlated. The graph below plots the relationship from 1950 to 2006. What’s most important about the graph is the slope of the fitted trend line, which suggests that small increases in GDP growth lead to significant increases in steel demand growth. In fact, this historical data suggest that for each 100 basis point increase in GDP growth (for example from 3% to 4%), the annual rate of steel demand growth increases almost four times as much.  So yes, the relatively small increase in global economic growth, from 3.5% to 5%, does help explain why the steel industry has been growing at 6% per year.

Global GDP Growth vs. Global Growth in Steel Demand

Sources: IISI, IMF, First River

But can the global boom in steel demand last? For a couple of reasons we think it can. First, while there are risks in the global economy, the credit crisis in the US being one of the more worrisome, the latest forecast from the IMF (namely the World Economic Outlook) is fairly bullish. Global GDP is expected to continue growing at around 5% annually through 2012. Given the historic relationship between GDP and steel demand this would suggest the global steel market will grow by at least 5% annually through 2012. Since steel demand has grown steadily since 1998, this seems an aggressive forecast. Can a “cyclical” industry sustain growth rates of 5% for over a decade without a cyclical downturn?

We think it can because it’s done so in the past. From 1950 and 1975, global GDP growth averaged 4.8% annually and steel demand grew at 6% per year. More important, during this period there were only four years when steel demand shrank from one year to the next. Steel demand is not really as cyclical as we have come to believe. It just happened to have gone through a particularly difficult period during the 1980s and 1990s.

The implication of the logical relationship between GDP growth and steel demand is clear. The global boom in the demand for steel and other commodities is a natural by-product of economic development and faster global GDP growth. If the economic forecasters are right and we are in for an extended period of 5% global GDP growth, the steel market should remain buoyant for a decade or longer.