by John Jagerson | December 7, 2011 8:10 am
In a time when everybody on Wall Street seems to be focused on high-flying social-media companies like Facebook, LinkedIn (NYSE:LNKD) and Groupon (NASDAQ:GRPN), it’s easy for companies in more “boring” industries to get overlooked. After all, who cares about fertilizers, paper or, heaven forbid, steel, right? If you’re interested in investing in value stocks that are poised to break out, you should.
If Ayn Rand showed us anything in her best-selling novel Atlas Shrugged, it is that the backbone of any industrialized economy is built with steel. America is built on it, China is built on it, and so is the rest of the emerging global economy, and steel producers like AK Steel (NYSE:AKS) stand to benefit as the global economy regains its footing.
U.S. steel industry stocks have taken a bit of a beating since the midsummer bearish plunge in stock prices, but rising auto sales and increasing durable goods purchases should give AKS the boost it needs to jump up and through the $9 neckline of the inverted head-and-shoulders pattern that has been forming on the stock since early-August (The stock is currently at around $8.75.)
Consumers are finally starting to buy new cars and trucks in numbers that are getting investors excited. According to Autodata, auto sales jumped 14% in November, bringing the seasonally adjusted annual sales rate up to 13.63 million. That’s a lot of cars and trucks.
And what are all of those cars and trucks made of? Steel. Sure, cars may not be as heavy as they used to be – where have all the fins gone? – but the skeleton of every car or truck on the road today is still made of steel. In fact, AK Steel sends about one-third of the steel it produces to the automotive industry. So as consumers start demanding more and more cars and trucks, car and truck manufacturers are going to be demanding more and more steel.
Cars and trucks aren’t the only big-ticket items consumers are buying these days. According to the U.S. Census Bureau, durable goods orders are up more than 9% this year compared to last. That means consumers are buying more refrigerators, washers and dryers and other large appliances and businesses are buying more heavy equipment and industrial machinery.
And what are all of those large appliances and pieces of heavy equipment and machinery made of? Of course you know the answer — steel. AK Steel sends another one-third of the steel it produces to producers of durable goods, and demand for that steel continues to grow.
Since its 50% drop from $16 to $8 in late-July, early-August, AKS has been consolidating in a classic reversal pattern: an inverted head-and-shoulders pattern.
This is characterized by a single resistance level – which forms the neckline of the pattern – and three distinct support levels – which form the left shoulder, the head and the right shoulder of the pattern. The support level that forms the head is the lowest of the three support levels, and the two support levels that form the two shoulders are typically just about level with each other.
In the AKS chart below, you can see the stock formed the left shoulder in August, the head at the end of September and the right shoulder in November – with the neckline running across that entire time span.
Once the stock breaks up and through the neckline, it doesn’t have much resistance between that level at $9.50 and the $16 price point from where the stock started to fall this summer. We expect the stock to break up and through the neckline of the inverted head-and-shoulders pattern and continue higher until it reaches the $14 to $17 trading range it was channeling in earlier this year.
If you’re interested in trading options on AKS in anticipation of the breakout higher and through the neckline of the inverted head-and-shoulder pattern, you need to make sure you give yourself plenty of time before expiration. Don’t get caught with a looming expiration date at the same time you are waiting for a breakout above the neckline.
If you want to decrease the amount of money you have to pay up front for the time value you are buying, you might want to consider entering a bull-call spread with an at-the-money, or slightly out-of-the-money, strike price for the long leg and an out-of-the-money strike price just below or at the target price for the short leg.
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