Investment Contrarians

Demand for Steel Unexpectedly Jumps; and These Stocks Now Look Good

By for Investment Contrarians |

Demand for Steel Unexpectedly JumpsWhen developing an investment strategy for a given market sector, you need to consider numerous variables. Increasingly, the variables are becoming far more complex due to the global nature of business these days.

One market sector that many analysts pay close attention to is the steel industry. Because steel is used in so many parts of an economy, signs of increasing or decreasing production can help give indications as to how strong or weak the global economy is operating.

Of all the countries in the world, China is a huge player in the steel market sector. When looking at an investment strategy that incorporates steel and iron ore, which is the main ingredient in the production of steel, trying to determine current and future output by China is crucial.

According to the Chinese National Bureau of Statistics, crude steel production increased 9.8% in February, breaking the previous record set in January. Both the real estate and automobile industries within China have regained momentum, resulting in an increase in investments in factories and other fixed assets by 21.2% during the first two months of 2013, versus the same time period in 2012. (Source: Yap, C.W., “China’s steel production climbs 9.8%,” Wall Street Journal, March 12, 2013.)

Additionally, those investors whose investment strategy incorporates the steel market sector based in America might see this as a cautionary sign: not only are the Chinese producing a huge amount of steel domestically, but exports of steel rose 25% from the year-ago period.

And remember, the steel market sector within China is a money-losing proposition. Most steel makers do not make a profit in China, and having an investment strategy that has companies competing with these Chinese steel makers, it will be difficult—if not impossible—to produce strong earnings growth.

From a logical point of view, it makes little business sense as an investment strategy for China to produce so much steel. According to the China Iron and Steel Association, the country produces 35% more steel capacity than is required. From a political viewpoint, employing people is their goal, not profits.

Interestingly, data regarding the iron ore market sector show Chinese steel producers are not aggressively buying new supplies of iron ore, but are simply using stockpiled inventory. The combined iron ore inventory level at 30 major Chinese ports has dropped to its lowest level since January 2010. (Source: “Iron ore stocks fall at China’s major ports,” China Daily, March 12, 2013.)

Furthermore, Chinese customs information reports that iron ore imports decreased by 13.2% in February, versus the same month in 2012. This is interesting, because steel production is now ramping up significantly; recent data from the steel industry purchasing managers’ index (PMI) also rose substantially to 58.9 in February, versus 49.3 in January.

I would consider looking at an investment strategy that might incorporate the iron ore market sector. If steel production continues at the pace that China is currently running, the iron ore market sector will benefit from this investment strategy; once the stockpiles have been depleted, Chinese steel manufacturers will have to go into the market and purchase more iron ore.

Two stocks in the iron ore market sector include BHP Billiton Limited (NYSE/BHP) and Rio Tinto plc (NYSE/RIO). Both of these have sold off significantly recently due to fears of a global slowdown.

However, with many companies in the iron ore market sector reducing supply due to worries of future demand, if Chinese steelmakers continue ramping up production, this investment strategy might yield positive results from the combination of future increased demand and reduced supply levels.

At this point, I would want to see additional data to verify that the increase in production is sustainable. Until that point, I would continue developing an investment strategy based on the data as they come out in this market sector.

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