3 Reasons to Buy the Steel Stock Rally

by James Brumley | November 11, 2013 9:38 am

Given the average 27% gain for steel stocks since the middle of this year, it would be easy to be a little suspicious right now. After all, it’s widely known that the industry has been plagued for years by overcapacity and tepid steel prices. So what’s driving the long-dormant steel stocks up now?

Well, as it turns out, steel prices have been firming up for a while, and demand has finally (almost) caught up with production capacity.

In other words, the slump is over; the recent rally from the likes of U.S. Steel (X[1]) and AK Steel (AKS[2]) is unfurling for all the right reasons.

Better still, more of the same bullishness for steel stocks might be in store for 2014.

Steel Is for Real

It’s admittedly a more philosophical idea than some investors care to entertain, but “the market” is rarely wrong — if the steel industry’s stocks are on the mend, then we have to trust that enough investors know enough about the true condition of the steel market to justify stepping into them now after ignoring them for years.

It doesn’t hurt that Goldman Sachs recently upgraded the steel sector’s stocks[3], of course. AK Steel was newly deemed a “buy,” along with U.S. Steel and Steel Dynamics (STLD[4]). All of them are being boosted by the ongoing boom in the North American gas and oil industry, which in turn fuels the need for steel (tubes and pipes in particular).

Bluntly though, while Goldman’s optimism is encouraging, it’s also a bit of a Johnny-come-lately call, and it didn’t even acknowledge a handful of the other key clues suggesting the steel rally is for real. Those other clues, in no particular order:

• The price of steel — the final arbiter of any debate surrounding steel’s demand — is as strong as it’s been in more than a year.[5] Hot rolled steel coil prices now stand at 32.5 cents per pound, up from a multiyear low of 29 cents per pound seen in April. Cold rolled coils are now priced near a 12-month high of 37.5 cents per pound. Rebar prices are close to five year highs, at 39 cents per pound. Prices will ebb and flow from one day to the next, but for the market to sustain these kinds of price increases can’t mean much else other than real demand from paying customers.
• The price of coking coal grew about 5% since the end of the third quarter — for coal miner Walter Energy (WLT[6]), anyway — and European coal miner New World Resources reports that its contracted delivery prices for coke in the fourth quarter are 11% higher than the third quarter’s average price[7]. Since coking coal, or metallurgical coal, is the material used to smelt iron, the fact that demand for it has grown suggests steel producers are already seeing demand ramp up at least enough to merit higher smelting material prices.
• The Baltic Dry Index (of maritime shipping costs) has risen considerably since June, from a low of 806 to the current price of 1600[8]; it had been as high as 2115 in early October. Although dry bulk vessels can carry all sorts of goods, the bulk of the recent charters and subsequent rise in charter prices has been fueled by a serious ramp-up in requests to haul iron ore… and most of it is bound for China, where steel production is already up 10% this year. Yet, it still isn’t enough. Forecasters believe demand for steel in China will grow at an annual pace of 3% to 4% through 2020, and the recent surge in iron ore charters validates the outlook. Considering the country drives 45% of the world’s demand for steel, if China’s buying a lot more steel and iron ore than usual, global supplies will be tightened.

Point being, if 2014 isn’t going to be a year of significant growth for steel producers, then a lot of people inside as well a outside of the industry are wrong in a huge way. That’s unlikely, though.

The plausible explanation for all these clues is just what it seems: Better days are around the corner, even if only as a self-fulfilling prophecy where demand rises to meet the highly accessible supply.

Bottom Line

While the rebound in steel stocks might have gotten a little ahead of itself over the past couple of weeks, any dip from names like AK Steel, Steel Dynamics or U.S. Steel is ultimately a buying opportunity.

Make no mistake, though — an investment in the major steel stocks here is an investment in a global economic rebound. A meaningful rebound here or abroad might feel out of reach. Just bear in mind, however, that Q3’s GDP growth rate for the United States was just reported (the first of three guesstimates anyway) at 2.8%, following Q2’s confirmed growth of 2.5%. China’s GDP growth for the third quarter, though still less than the red-hot growth rate from yesteryear, was still a solid 7.8%.

A trade in steel stocks might not be a bad bet here, even if it’s an unpopular idea. Indeed, steel may be a good bet specifically because it’s an unpopular premise.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2013/11/steel-stocks-x-aks-stld/

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