Is Steel A Steal?

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Includes: GLNCY, RIO, SLX, VALE, X
by: Andrew Hecht

Summary

A growing economy is supportive for steel.

The iron ore price has more than doubled.

Infrastructure rebuilding will create more demand.

U.S. Steel may have rallied dramatically, but it still may be cheap.

The ultimate bet on global growth.

In 2013, the price of iron ore was north of $150 per ton and in 2008, U.S. steel shares peaked at $196. The global financial crisis of 2008 took the U.S. housing market dramatically lower, and the sovereign debt crisis, increasing unemployment, and waves of immigrants arriving on a daily basis in Europe caused economic activity to grind to a halt. The central banks of the world slashed interest rates and instituted programs of quantitative easing to stimulate economic growth by encouraging borrowing and spending and inhibiting saving. The demand for raw materials declined sharply from 2011 through 2015, and when the Chinese economy began to cool, the industrial commodities suffered from a lack of buying from the world's leading consumer.

In late 2015 and 2016, the situation in the world of commodities for raw materials that are the building blocks for infrastructure reached a crisis level. In December 2015, the price of iron ore fell to $38.03 per ton after having traded at $157.30 less than three years before. U.S. Steel (NYSE:X) moved to a low of $6.15 per share in January of 2016 after having sold at $196 before the economic travails that gripped the global economy in 2008.

Both the prices of iron ore, the main ingredient in steel, and steel itself have rebounded over the past year. Economic conditions in the United States and around the world have stabilized and seem to have turned the corner. Right now, if the trend since early 2016 continues, U.S. Steel could be a steal at its current price level.

A growing economy is supportive for steel

When it comes to infrastructure building and buoyant economic conditions, the prices of few raw materials are as sensitive to a pickup in construction as steel. According to the U.S. Federal Reserve, the American economy stabilized in 2014 causing the central bank to taper the QE program and end asset purchases. As the data continued to improve, moderate growth and a better employment picture caused the Fed to begin to consider a hike in short-term rates from zero. The first interest rate increase in the Fed Funds rate came in December 2015. Higher interest rates tend to be a bearish factor for commodity prices, but the reversal of fortune for the economy was a sign that demand would eventually pick up and construction projects would once again be humming. All the while, the lowest interest rates in history caused housing prices across the U.S. to come storming back, and demand for new construction increased.

The election of Donald Trump as the forty-fifth President of the U.S. gave the prices of industrial commodities another shot in the arm. The President ran on a platform advocating for the largest infrastructure rebuilding program in the nation since the Eisenhower Administration in the 1950's. With both houses of Congress from the same party as the new President, he has continued to pledge to rebuild America's crumbling roads, bridges, tunnels, airports, and to construct a security wall along the southern border of the nation. While the machinery has not begun humming just yet, the prospects for a new industrial revolution have lifted the prices of iron ore and steel over recent months.

Moreover, it now appears that Europe has avoided a deflationary catastrophe and the Chinese economy seems to be stable. It is likely that we witnessed an over- extension to the downside for industrial commodities prices and companies in late 2015 and early 2016. We are now in the midst of a significant recovery period in the sector. A return of growth in the U.S. and world economies is highly supportive for the price of steel and other industrial raw materials.

The iron ore price has more than doubled

The price of iron ore is currently sitting near recent highs. Source: Barchart

As the chart highlights, iron ore futures traded to lows of $38.03 per ton in December 2015 as the bear market in commodities took the prices of most industrial commodities to multiyear lows in late 2015 and early 2016. In February 2013 the primary ingredient in steel had risen to $157.30 so in just under three years, the price declined by over 75%.

Commodities price tend to be volatile, and when they move to peaks or lows, they often overshoot levels of resistance on the upside or support on the downside where economic forces would otherwise cause them to pause and reverse. In hindsight, the low at $38.03 was an overextension. A little over one year later the price of iron ore has recovered to recent highs of $91.76 on the April futures contract, over 140% higher on the April futures contract. Percentages can be misleading; the price of the industrial commodity fell $119.27 from 2013 through late 2015 and has rallied by $53.73 since the most recent lows. As of Wednesday, March 22 the price had corrected from recent highs and was trading around the $83.84 per ton level.

Infrastructure rebuilding will create more demand

The ascent of iron ore occurred because the price had overextended on the downside in late 2015. On the day of the Presidential election, November 8, April iron ore futures closed the session at $60.27. The victory of a Republican candidate who campaigned for office on a platform of infrastructure building likely caused the next leg of the rally in the price of iron ore and many other industrial commodities as construction projects in the United States will increase demand for steel and the other basic building block raw materials.

U.S. Steel may have rallied dramatically, but it still may be cheap

One of my favorite lines from the epic movie classic, "The Godfather Part 2," is when Hyman Roth tells Michael Corleone, "We are bigger than U.S. Steel." Over many decades, U.S. Steel has not only been one of the greatest and most influential companies in the United States; it has been a symbol of the nation's industrial prowess.

As commodity prices hit multiyear lows in early 2016 U.S. Steel dropped to a price most thought unimaginable just a few short years before, when X traded to $6.15 per share. Source: Barchart

On September 15, 2014, X was at the $46.55 per share level, so the decline of 86.8% was dramatic. However, considering that in June 2008 the price of the company that is a U.S. institution traded to an all-time high of $196 X was 96.9% off its peak price. The price action in X is a representation of how economic conditions, technology, and foreign competition decimated the U.S. steel industry over recent years. Hyman Roth would never have compared his enterprise to U.S. Steel over the past several years or even today perhaps. He would have likely used Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT), or Berkshire Hathaway (NYSE:BRK.A) for the analogy. Meanwhile, the potential for infrastructure building in the U.S. and signs of global economic growth after an extended period of lethargic conditions, U.S. Steel was trading at around $34.73 per share on March 22, over five and one-half times the price seen just fifteen months earlier.

The ultimate bet on global growth

At just under $35 per share, X remains at less than one-fifth its all-time highs seen nine years ago. In 2008, when U.S. Steel was on its highs, the price of iron ore was trading below $70 per ton, lower than it is today, but it was on its way to all-time highs of $187 in February 2011.

We are seeing positive signs when it comes to the global economy and given the current level of optimism, positive economic data, and the potential for an increasing number of construction projects in the United States it is possible that the demand for steel will rise in the months and years ahead. Additionally, over recent years slowing economic growth in China and a sluggish European economy weighed on the demand for many if not most industrial commodities and prices dropped to multiyear lows. The trend of price recovery over the past year in iron ore, steel, and U.S. Steel shares could just be the start of a much larger move in the sector if pledges of infrastructure building in the U.S. turn from promise to reality and economic conditions around the world continue to improve. If that is the case, steel could be a steal at its current price, and the price of X will once again rise to a level where it could be a valid benchmark for grandiose comparison.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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