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Steel and Its Fair-Weather Friends

By Stansberry Research Interview Series
Wednesday, October 11, 2006

Much has been written about the madness of crowds. But Baltimore Ravens fans have a particularly type of bipolar lunacy: the fair-weather fan syndrome. They can praise a particular player as a godsend, then curse him as worthless all within a span of 30 seconds.
Steve McNair got a taste of Baltimore’s mercurial favor two Sundays ago when Ravens fans began calling for his predecessor Kyle Boller following his first interception of the game. I’ve heard a lot of fan cheers in my life, but “Boller” has to be one of the strangest, given his lackluster career: Boller was ranked 30th for quarterbacks in the NFL in 2004.
You see a similar fair-weather fandom expressed today in the industrial metals sector, most notably steel companies. Now, Baltimore’s a former steel town, but I’m not enough of a conspiracy theorist to think that’s the connection. However, the fair-weather factor for steel has made for a terrific trade for us.
Steel was a four-letter word amongst investors for much of the last 30 years. Between 1970 and 2000, steel consumption only grew an average of 1.9% a year. However, starting in 2000, China’s infrastructure needs kicked off a resurgence in the metals’ popularity. Over the next five years, global steel consumption would grow by nearly 6% a year. During that time, steep prices tripled.
The steel industry entered a period of consolidation. Steel heavyweights, such as Mittal Steel, US Steel, and Nucor, began acquiring smaller competitors in an effort to create some degree of production and subsequent price control in the industry.
However, during this period of consolidation, the steel boom cooled. China’s production finally caught up with its consumption. As a result of this, steel prices fell 22% from January ’05 to February ’06. Steel investors showed their fair-weather colors, dumping shares at steel companies like they were carcinogenic. Share prices at steel companies collapsed, falling over 50% in the a few months’ time.
The sector has since begun a recovery. Historically, steel companies have performed well in the third and fourth quarters of the year. According to Thomson Research, the materials sector is expecting earnings growth of 46% in 3Q06. It’s the highest earnings growth of any sector.
At the top of the list is US Steel (X).
However, I think the good news is already discounted into US Steel’s share price: Shares are up 18% in the last month. And this rally took place in the face of a glut in steel supplies in the US.
Service centers, which account for a third of US steel purchases, recently told The Wall Street Journal that inventories are at their highest levels since January 2005. Simultaneously, steel imports are up 40% from last year.
I think we’ll see a continued rally in US Steel shares up until its 3Q06 earnings announcement on October 31, 2006. Like Baltimore Ravens fans right before an interception, steel investors will be hoping for the best.
However, once earnings are announced, the fair-weather factor will kick in. The good news will be old news, and there will be nothing to look forward to but softening steel prices on over supply and lower demand.
At that point, US Steel will be an excellent candidate for a short sell.
Good trading,

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Market Notes
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In The News: Oil hits lowest level since February.
Market Watch
Symbol Price
S&P 500 1221.53 +1.3% +10.1%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%