Is Now the Right Time for Steel?

by: Hard Assets Investor

By Aaron Levitt

With so much investor attention being thrust toward gold, oil and corn, many other commodities are almost going unnoticed. Just look at steel.

Prices for steel, which forms the backbone of our modern infrastructure, have quietly climbed higher, as the recovering global economy has buoyed demand for everything from tankers to appliances. The Wall Street Journal reports that after a summer of soft prices and excess supply, steel prices have rebounded as much as 12 percent depending on the variety and location of production. And despite many analysts' predictions for weakness in the steel market to continue into 2011, many Japanese and European producers have pushed for net increases in production.

With analyst negativity comes investor opportunity. Looking toward the long term, steel represents one of few commodity "value" buys left.

A Rusty Near-Term

The latest import data from China shows declines in a broad range of commodities, but steel imports were one of the few bright spots. Market Watch reports that Chinese iron-ore imports were up 12 percent in October.

As the world's largest steel producer, China's pull in the sector is enormous. Last summer, the country cut production in order to meet new energy standards sanctioned by Beijing, and the resultant drop in global inventories sparked an August rally in metals worldwide. More recently, Beijing's decision to raise interest rates for the first time in over two years also kicked up dust on the global steel market.

But Chinese demand alone isn't enough to carry the entire market. Demand has flagged worldwide, and according to the U.K.-based steel group, MEPS, the current slack in global demand has caused hot coil steel prices to retreat from their summer highs. Both Canadian and American facilities have seen shutdowns and decreased production capacity, while mills in Czech Republic, South Korea and Poland have also experienced demand declines. Meanwhile, Taiwanese mills have kept prices purposely low to help their customers stay competitive.

But while steel's short-term prospects may look dim, this current pause may in fact be the perfect time for investors to gain access to the sector.

Longer-Term Trends

CIBC World Markets estimates that over the next 20 years, emerging and developed markets will need to spend nearly $35 trillion on upgrading infrastructure. From new water treatment facilities to roads and bridges, steel forms the backbone of it all.

The World Steel Association reports that although global steel demand will slacken in 2011, it will still hit a record 1.34 billion tons (an increase of 5.3 percent). That will largely be propelled by Chinese demand, which will be 42 percent above pre-economic crisis levels of 2007. But India too will make an impact: The country is poised become the world's third-largest steel consumer, and demand should rise more than 13 percent in 2011 to 68 million tons.

In addition, the Federal Reserve's recent decision to start its second round of quantitative easing should help boost prices for natural resources. Potential inflationary pressures, as well as worries about the stability of the greenback and other Western currencies, have generally sent investors flocking to hard assets of all kinds.

Investors looking to add a steel component to their portfolios do have plenty of choice with regard to the sector. Steel futures trade on both the NYMEX and LME, and a range of diversified metals miners ETFs trade on most U.S. exchanges. Investors can also look toward equity ETFs. The SPDR S&P Metals & Mining ETF (NYSE Arca: XME), for example, includes a nearly 32 percent weighting toward steel.

But finding pure-play steel exposure in ETFs is harder. Investors have just two exchange-traded options: the Market Vectors Steel ETF (NYSE Arca: SLX), and the PowerShares Global Steel Portfolio (Nasdaq: PSTL). Both base their portfolios on equities, rather than futures.

But another of the major beneficiaries of increased steel production has been the scrap metal recyclers. New reports from analysts at Canaccord Genuity and Deutsche Bank suggest sustained higher ferrous scrap prices in the years to come; in fact, Deutsche Bank analyst David Martin sees the potential for scrap prices to increase by nearly $60 a ton.

With operations across five continents, Australian firm Sims Metal Management Limited (NYSE: SMS) remains the world's largest metals recycler. Economies of scale have helped Sims recently report its fifth consecutive profitable quarter since the economic downturn began. Naturally, future increases in steel demand would only continue to help the company.

For a more domestic play on scrap recycling, small-cap Metalico (AMEX: MEA) operates 24 metal recycling plants across the United States.