My next big idea is a short position on U.S. Steel given the near term macro uncertainty in China and on-going efforts by the Chinese Central Bank to shore up its balance sheet due to worsening credit conditions. Furthermore, the entire Chinese consumer economy operates at a record GDP to Debt ratio, I can’t recall the figures off the top of my head, but I believe it was at 400%+ for the aggregate household, government, corporate plus municipal debt. While, it’s hard to establish the data corollary, I believe the Chinese Central Bank is signaling a slowdown in overall open market purchases as they shore up their balance sheet to mid-teen common tier-1 equity. This implies that the Chinese Central Bank won’t be there to bolster up demand with open market activities as it’s anticipating a massive reduction in CNY liquidity, as it’s currently utilizing its balance sheet to fund bailout of failing state owned enterprises across all sectors, particularly banking. The recent expansion of stimulus spending pertaining to rail roads and various other infrastructure projects has sustained the economic expansion, but recent papers written by Oxford Economics imply that the economic efficiency of these projects should be questioned despite near-term Keynesian like outcomes on aggregate inflation.Nonetheless, the Chinese government is signaling a slowdown in their fiscal consumption patterns, which implies that the broader commodity market is overbuilt in terms of supply with China being the price setting commodity buyer/producer for Steel products at 50% of worldwide steel consumption. Recent deleveraging of balance sheets among municipalities and state owned enterprises implies that the rate of Capex expansion should slow given enough time. Source: CMEHence, the broader iron ore market has readjusted to these realities with an inverted pricing curve, or what many simply refer to as contango. While the market is pricing in overall commodity pricing at consistently lower levels, sentiment on steel products has improved in the past couple quarters. Some are even speculating that lower iron ore prices should translate into higher margins assuming steel prices remain constant. However, the two complement each other, and are pricing in two different economic realities. The mid-west Domestic Hot-Rolled Coil Steel assumed backwardation or increased pricing along the curve.This doesn’t seem consistent, and if iron ore pricing does in fact decline, it’s more likely that steel makers will attempt to compete for more market share by reducing the price of steel to compete for higher volumes. In other words, lower input costs for Steel also translates into lower pricing for steel. The market is heavily sensitivity to pricing and steel producers have more incentive to lower pricing on reduced input costs than to increase margins given the hyper-competitive nature of commodity based industries.I believe China’s recent efforts to communicate economic certainty have fallen upon deaf ears, and with the CNH/USD trading at near all-time highs. It implies that the market is prone to correction as opposed to runaway inflation. Currently, China’s CPI or inflation rate hit a record low of 1.3% y/y, which compares to the United States at 1.1% y/y. Source: FreestockchartsSo, just why in the hell is the USD/CNH appreciating so quickly against the Chinese Yuan? If the United States inflation rate is pacing 20 bps below the Chinese Yuan, why is the USD/CNH able to sustain a rally of 4% from its year low? Think about it, the Chinese Yuan devalues by 4% when its rate of real inflation is just .2% better than the United States? That’s so inconsistent with economic reality that it can only imply market speculation paired with hope of continued currency purchases by the PBOC. The PBOC’s open market operations is hamstrung by their recent deleveraging of their balance sheet, in conjunction with the government’s fiscal policy stance shifting in response to worries over credit conditions in China. The Chinese Government’s debt to GDP ratio of 247% already topples Japan’s record-setting debt to GDP ratio at 245%. Yet the CNH/USD is on pace to reach new all-time highs in an environment where the United States is unlikely to raise rates given uncertainty on inflation targets. In other words, the currency market is pricing in some form of Chinese reflation, but this runs counter to the PBOC’s recent stance of deleveraging its balance sheet, which should translate into slower monetary flows, or reduced multiplier. We haven’t seen this effect yet, but if the currency market is wrong (which it likely is), the Yuan should correct pretty soon to reflect relative rates of inflation over implied policy outcomes. In other words, the PBOC can’t expand its balance sheet without risking destabilization, and so the cat and mouse game of expansionary policy or fiscal conservatism is weighing on the minds of economists and traders alike. I believe the recent rally in the dollar has more to do with asset flows, with investors fleeing and fleecing their bank accounts in favor of U.S. assets. But, flows are temporary in nature, and eventually the market will reflect actual economics, as in China is heading towards deflationary pressure, and the currency markets will soon reflect that impact with the Chinese currency making gains against the aggregates global currency basket. In other words, the Chinese export economy could come under question the moment the Yuan swoons, which will happen in the next six to twelve-months. Bank deleveraging = less liquidity = deflation. The CNY is pricing future inflation when in reality the monetary base will contract. The moment the CNY strengthens, the demand for global commodities will drop, because Chinese exports become more expensive on a exchange rate basis. In fact, Chinese exports were weak in the past week declining 10% y/y. Now, what happens if the Chinese Yuan corrects once asset flows stabilize, and the currency trades in-line with export/import based fundamentals? The CNH tanks, and the competitiveness of exports will dry up that much quicker, which then translates into massive commodity price destabilization.In that environment, I could easily imagine steel prices cratering. The moment China’s industrial engine hiccups and currencies respond to real-market fundamentals, the U.S. based steel makers will be victims of external forces on supply and demand. In other words, U.S. Steel’s recent guidance is unlikely to materialize, because it assumes the price of steel will remain constant. But not in a world where Chinese exports are cratering, the currency is on the cusp of major volatility, and the PBOC is shoring up its balance sheet. That’s a toxic soup cocktail for commodity based industries, and it’s likely that the elephant stampede out of China will impact the steel makers.U.S. Steel hit a break-even point in the past quarter ending in June, and in the three month span the hot rolled coiled steel was trading at $500 to $560 per metric ton. Now, the price of steel has cratered from its high of $560 and is hovering at around $500. Key support area, but with Chinese export metrics weakening, and fiscal stimulus slowing… well you get the drift. Commodity markets look out below! If you’re making a stock based play, I think U.S. Steel is vulnerable given its uncompetitive global positioning given higher wages, and exposed balance sheet. Imagine if prices swooned again, wouldn’t C&I (commercial and industrial) loan liquidity drop? Isn’t it going to translate into debt downgrades by the major credit rating agencies? We saw the banks reduce their exposure to C&I loans in the past year, and I can’t imagine how U.S. Steel will restructure its balance sheet when yields go up, price of steel goes down, and cost efficiency is unlikely to account for these two downward forces.Source: FreestockchartsIn other words, I could imagine steel prices tanking by another 25% or more this year, and I also anticipate that U.S. Steel will break below $10 in the next six-months. The symmetrical triangle formation will likely break down in the next week, which translates into a substantial opportunity to make above market returns.As such, investors should short U.S. Steel. I’m initiating with a high-conviction sell rating, as global macro, and market specific fundamentals cannot sustain the recent rally in iron ore or steel for much longer.