The steel industry, as tracked by the Market Vectors Steel ETF, was one of the biggest success stories of 2009, gaining over 110%. In 2010, the fund has already shown signs of seeing a repeat performance, doubling the performance of the
in the first quarter.
Three factors carrying the fund include the broad global economic recovery, heavy allocation to top iron ore producers and strong U.S. exposure.
Global Economic Recovery
Steel is often looked at as the backbone of economic expansion, due to its use across a broad variety of industries including infrastructure and automobiles. Investors and market analysts look to demand for the metal as a bellwether for the current status of the global economy.
Today the economy is on the rebound and, as expected, global steel demand has seen a dramatic uptick. Investors looking for evidence of this reversal need only recall SLX's dismal 2008 returns compared to its 2009 boom. While last year the fund turned in triple-digit returns, in 2008, amidst the throes of the global economic downturn, SLX slumped nearly 65%.
SLX tracks a diverse, international basket of companies, which allows it to play all facets of the global steel industry. This has paid off in the past year and should continue to pay off as the global economy remains on the path to recovery.
Iron Ore Contract Adjustment
Over the past few weeks, top iron ore producers
and BHP have managed to persuade leading Asian steel makers to adapt a new, quarterly contract pricing method -- thus doing away with annual contracts that had been employed for the past 40 years. South Korea's
became the most recent mills to jump on the bandwagon when it agreed to follow suit on Monday.
Last year's market strain caused the annual price negotiators to settle on low iron ore prices. As the global market recovered, these low ingredient costs allowed steel makers around the world to produce their product cheaply. However, it also meant that miners had to sacrifice huge profits.
By switching to quarterly pricing, iron ore can sway with the market, allowing miners the benefit in times of economic strength. On that score, Posco just tentatively agreed to an 86% increase in iron ore prices.
Though high ore prices will weigh on steel mill profit, SLX's design allows it to benefit from the revolutionary negotiation shift. Despite being designed to track the steel industry, the fund's top holdings are iron ore producers Vale and
( RTP), two direct beneficiaries of the quarterly contract method.
Iron ore producers' decision to shift contract negotiations to a quarterly system from the traditional annual method will put pressure on the steelmakers who depend on BHP, Rio Tinto and Vale for the ingredients necessary to produce their product. Analysts predict that the prices for these miners' iron ore could nearly double, causing steel prices to increase by one third.
Luckily for investors holding SLX, the fund's geographic exposure puts it in a prime position to benefit from these cost increases. More than 40% of SLX's portfolio is allocated to U.S. companies. Some representatives include
United States Steel
( GNA) and
Interestingly, the United States is in a unique position that sets it apart from other steelmaking nations. Unlike Japan, China and the E.U., the U.S. not only produces steel, it also happens to be a net exporter of iron ore, coking coal and other chief ingredients of the base metal. This unique cost advantage should benefit the nation's steel exports as other nations struggle to cope with their newly increased input costs.
These three factors mean there is a strong chance that the recent outperformance in SLX will continue well into the next quarter.
-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion had no positions in stocks mentioned.
Don Dion is president and founder of
, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.
Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.