Steel stocks: A contrarian buy

Even if we see S&P earnings fall 10%, 20% or even 30% from recent levels, I doubt that the stock market has much further to fall.

In fact, I suspect that investors who scoop up shares now of excellent stock ETFs will be glad they did several years from now. As such, we are adding Market Vectors Steel ETF (SLX) to our Contrarian Portfolio.

Slowing economic growth has tempered expectations for steel makers, and their prices were savaged in early August 2011, losing nearly 15%.

For the year through Aug. 31, Market Vectors Steel is down about 23%, despite a 10% rebound off its low point in mid-August.

We think this steep decline overly discounts steel makers�prospects and provides an attractive contrarian opportunity in SLX.
Despite the drop in steelmakers�share prices this year, steel shipments have risen strongly. U.S. and Canadian companies together shipped more than 3.5 million tons of steel in July 2011, up 9% over July 2010.

July�s shipments boosted totals for 2011 to 27.6 million tons, an increase of 16% over the same period in 2010.

Prices and overall profitability have improved from their nadir in 2009. Higher prices and profitability have come largely from demand in emerging markets, which consume 80% of the world�s steel.

Non-residential construction remains depressed in the developed world, but in emerging markets (like Brazil, which is building out for both the upcoming World Cup and Olympics) remains robust.

Still, this year�s profits will be far short of 2008�s $13.5 billion, a peak level that was juiced by a shortage of both finished steel products and inputs.

With the rebound in profitability, nearly every major steel company has invested heavily in both expanded production and raw materials (including metallurgical coal and scrap steel).

SLX invests in 27 of the world�s largest steel makers, fabricators and iron-ore producers through shares listed on U.S. exchanges. U.S. and Canadian companies make up about 36%
of the portfolio, followed by Europe (33%), South America (23%) and Asia (7%).

About 25% of the portfolio is in mid-cap stocks, mostly specialized U.S. fabricators, but the largest companies dominate; nearly 70% of the portfolio is in the top 10 positions. SLX levies a 0.55% expense ratio.

The selloff in steel-related shares seems to discount a large decrease in demand. Many of these companies are in excellent financial health.

In addition, the biggest companies have made savvy moves to better control their input costs and diversify their geographical exposure.

With a mild valuation and underestimated potential, SLX looks attractive at recent levels.