Commodity Investing

The Pros and Cons of Dealing With Steel

Back in September, I wrote about the “real man of steel,” Lakshmi Mittal, Chairman and primary owner of ArcelorMittal ADR (NYSE: MT). His company produces nearly 10% of the world’s steel and three times more than his closest competitor.

Last fall, he disagreed with the largely downcast outlook analysts had about the industry. For that matter, he had an optimistic outlook even last July, when he predicted a 10% increase in steel output for 2010.

At the time, people didn’t think much of his forecast. But today, analysts actually expect 11.2% this year, which would more than compensate for the 10.3% decline the industry saw in 2009, the biggest drop it experienced in more than six decades.

Still, even with the promise of a new year with new results, investors should steel themselves with a few key facts before they put all their money into the metal.

China’s Steely Impact

Surprisingly enough, analysts don’t expect China to lead the global recovery in steel-making this year. In fact, while the Asian giant will still produce about 7% more of the commodity this year than last year, the rest of the world should actually outpace it for the first time in a decade.

Over the past ten years, global steel output would have declined by nearly 100 millions tons if not for China, which instead boosted it by over 300 million. It exerted intense influence on the industry’s growth with steady increases every year, contributing a sixth of the world’s steel in 2000 but accounting for nearly half today. Analysts expect that number to fall to 46% this year, but it’s still an impressive amount one way or the other.

Elsewhere, steel production should expand 15% in 2010, compared to last year’s estimated 24.8% drop. Putting that in perspective, the last time output fell that badly was in 1945, after World War II.

From January through November, India stood out as the only other large country to report positive steel growth. But while it increased production by 2.4%, Europe, Australia and the U.S. plummeted by 33% – 40% compared to 2008. Russia experienced a 16% drop, Brazil fell 25% and Japan declined 29%.

A Closer Look At The Steel Sector

Fortunately for the hard-hit steel sector, the expected pick-up in demand this year should keep prices relatively high. That should help companies like ArcelorMittal, which expects earnings of around $11.8 billion before interest, tax, depreciation and amortization. Compare that with an abysmal $5.8 billion in 2009 and a hefty $24.5 billion during the boom times of 2008.

But investors still worry that the uptick outside of China mainly represents automotive and construction companies rebuilding stock rather than reacting to any real increase in demand. In addition, Chinese steelmakers could very well drive up the price of raw materials – including iron ore and coking coal – further than they already have, hurting the larger steel industry even more.

And that doesn’t even take into account how China will doubtlessly increase exports this year as its own production capacity rises, albeit not as significantly as in past years. Any amount, however, would exert downward pressure on the actual commodity price, complicating the matter further. Needless to say, more expensive materials and less expensive products don’t make for very healthy businesses.

The Bottom Line For The Steel Industry

In the end, the recovery in the steel industry looks less than stable everywhere but China.

But all the same, investors should keep their eyes on ArcelorMittal, the proverbial canary in the coal mine. If the company does nothing, that’s a strong indication that the industry still needs more time to strengthen. And if Mr. Mittal begins to aggressively pursue acquisitions like he has in the past, take it as a strong signal to buy into steel again.

When that happens, investors should look at steel stocks including ArcelorMittal, Brazil’s CSN (NYSE: SID), or perhaps an exchange traded fund such as the Market Vectors Steel ETF (NYSE: SLX)

Good investing,

Tony Daltorio

*The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of Wall Street analysts.

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