Sage Investment Club

Female Steel Factory Worker at work Lim Weixiang – Zeitgeist Photos Introduction Over the past month, I have analyzed China, India, US infrastructure and the Russia – Ukraine war. In this article, I draw upon my prior analysis combined with new incremental drivers to form a bullish view on steel stocks. To play this theme, I consider the VanEck Vectors Steel ETF (NYSEARCA:SLX) to be the main vehicle. SLX ETF Exposure Mix Geography Mix SLX ETF Geography Exposure (SLX ETF Website, Author’s Analysis) Steel companies from the United States and Brazil make up more than two-thirds of SLX’s overall exposure. Note that this geography mix represents production mix across countries, not the sales mix. Top 5 Holdings Mix SLX ETF Top 5 Holdings (SLX ETF Website, Author’s Analysis) SLX’s top 5 holdings include Vale S.A (VALE), Rio Tinto (RIO) (OTCPK:RTPPF) (OTCPK:RTNTF), Nucor Corp. (NUE), Cleveland-Cliffs (CLF), and ArcelorMittal (MT) (OTCPK:AMSYF) (OTCPK:ARCXF) (OTCPK:AMSIY). Unsurprisingly, almost 25% of the overall exposure comes from two commodity rich countries; Brazil and Australia. Note that ArcelorMittal is merely headquartered in Luxembourg, Brazil and the United States make up roughly 10% of its overall revenues mix. An Ideal Demand – Supply Setup On the supply side, I see 2 key tailwinds supporting a bullish outlook on SLX: Subdued Chinese production Persisting supply-side shocks from the Russia – Ukraine war On the demand side, I see 3 key tailwinds supporting steel prices and production: Rebound of Chinese demand Uptick in Indian construction activity Rising US demand driven by the Infrastructure Investment and Jobs Act Supply-side tailwinds Subdued Chinese production China makes up more than 50% of global steel production. This makes Chinese steel production trends a major driver of global steel prices. A couple of days ago, Chinese commodity specialist research firm MySteel published a note expressing subdued Chinese production of steel: During 2023, crude steel production will continue to be impacted by the central government’s determination to ensure that steel output remains flat or below the previous year’s total. This reduces the risks of supply expansions in the global steel prices, thus making a strong case for elevated steel prices. Persisting supply-side shocks from the Russia – Ukraine war Russia and Ukraine together make up 10% of global steel trade. With the war escalating further, I believe we will continue to see supply side disruptions in 2023. This would support steel prices not only directly via the reduced supply of Russian and Ukrainian steel to the global market, but also indirectly via higher energy costs arising from cuts in Russian supply of natural gas leading to higher input costs for steel production. Demand-side tailwinds Rebound of Chinese demand China makes up more than 50% of world steel demand, making the country’s demand driver a key pendulum-swinger for global steel outlook. As the Chinese economy re-opened, I anticipated an uptick in Chinese steel demand. However, I became more cautious of this view as the country suffered another COVID outbreak. More recently however, there are early signs of China’s COVID cases peaking as hospital beds occupancy is waning. Indeed, at the World Economic Forum yesterday, IMF Deputy Managing Director Gita Gopinath stated that “China could see a sharp recovery from the second quarter onwards.” I believe the potential peak of the current COVID wave in China presents upside risks to steel prices as the Chinese economy resumes its return to normalcy. Up-tick in Indian construction activity Although by a wide margin relative to China, India is the 2nd-largest consumer of steel with an apparent steel usage share of 5.8%. I discussed in my previous article on India ETF EPI that India is seeing a construction sector up-tick. As Jayant Acharya, deputy managing director at JSW Steel, India’s largest domestic steel producer, noted: The nation-building phase of any economy requires a lot of steel and commodities. As the construction sector typically makes up more than 50% of overall steel usage, this is bullish for steel prices and hence for the constituents of SLX. Rising US demand driven by the Infrastructure Investment and Jobs Act Over the next 5 years, we will see the implementation of the Infrastructure Investment and Jobs Act (IIJA) that aims to revamp much of the United States’ outdated infrastructure. Federal guidelines state that steel products must be procured domestically in the United States. Naturally, this sets a very bullish tone for the US steel industry which has majority representation in the SLX ETF. Takeaway Overall, I see a lot of support for steel prices due to the demand and supply tailwinds discussed. Yesterday on 18 Jan, Nippon Steel increased the March deliveries’ FOB hot-rolled-coil (HRC) prices by 8.3% from $600/ton to $650/ton. This provides confirmatory signals for my bullish view on steel prices. Track Incremental Supply An attractive steel market can induce supply side expansions to upset the global demand – supply balance of steel. There are some instances of this already occurring; Nippon Steel Corp. and ArcelorMittal announced a joint venture investment of $8.3 billion to expand Indian steel production capacity by 6 million tons. In the immediate term, I believe this volume expansion would be beneficial for SLX as ArcelorMittal is the 5th largest holding in the ETF. However, I would be keeping a close eye on the overall supply expansions, particularly by the steel giant China as those moves may warrant a change in my thesis. Technical Analysis If this is your first time reading a Hunting Alpha article using technical analysis, you may want to read this post, which explains how and why I read the charts the way I do, utilizing the principles of Flow, Location, and Trap. Relative Read of SLX vs S&P 500 SLX vs SPX500 Technical Analysis (TradingView, Author’s Analysis) The relative chart of SLX/SPX500 shows price breaking out of the accumulation zone which was created over the last 8 years. I anticipate the price to go towards an immediate resistance level created in 2012-13. This level has seen historic volatility and sellers overpowered buyers at this resistance zone. Thus, I believe SLX will outperform the S&P 500 (SPX) (SPY). Standalone Read of SLX SLX Technical Analysis (TradingView, Author’s Analysis) On a standalone basis, SLX is anticipated to break the immediate resistance and go upwards. SLX is showing signs of accumulation before the local high is reached. $59 is acting as a key support level due to the historic volatility observed here. I believe $70 will act as a weak resistance that will be broken. Summary Overall, I see steel stocks in the SLX ETF supported by strong supply-side tailwinds involving subdued Chinese production and persisting supply-side shocks arising from the Russia – Ukraine conflict. This is coupled with constructive demand forces (pun intended) involving a rebound of Chinese demand, uptick in Indian construction activity and buoyant US infrastructure spending driven by the Infrastructure Investment and Jobs Act. I view incremental production expansions, especially from the steel giant China, as a key thesis-changing force that ought to be monitored. From the charts perspective, SLX looks poised to generate both absolute returns and relative outperformance over the S&P 500. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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