Steel and Its Fair-Weather Friends
by Graham Summers
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,
Graham 
