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Time to Bet on the Steel ETF

SLX

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The U.S. equity market continues its uptrend on the back of signs of recovery in the global economy. Now commodities are also showing a comeback after a steep fall earlier this year, and have caught investor attention in the past few weeks. This is especially true in the commodity producer segment like steel (read: 3 Mining ETFs Finally on the Upswing).

These producers usually act as leveraged plays on the underlying commodities. So when commodities are rising, these firms are truly the winners.

Behind the Surge in Steel

This corner of investing has seen some strength buoyed by the growing U.S. jobs market and rising consumer prices, encouraging trade data from China and cooling of recession in Euro zone. Meanwhile, a more sluggish dollar of late hasn’t hurt commodity, boosting demand for this product.

Apart from this, there are signs that China is working to cut capacity in its steel industry. The National Business Daily indicated that China could reduce capacity in the sector by 400 million metric tons. The reduction is expected to amount to about 40% of China’s steel capacity. A reduction in capacity could help pricing power among global steel producers (read: Focus on These China ETFs for Outperformance).

Given tightening supply and heavy steel re-stocking in China, steel price has rebounded from 3.5 years lows in recent weeks. The blast furnace outages in Ohio and Brazil as well as work stoppage in Ontario disrupted about 4% of the total U.S. steel supply in the past three months, leading to higher prices. 

Further, a major component of steel - iron ore – climbed to its highest level in five months, on rising demand from China, thereby leading to higher steel prices. The iron ore is poised to benefit further this year as chances of the Fed tapering its bond buying program in September has increased. If iron ore price rises, the price of steel will definitely increase.

Steel ETF in Focus

For those buying into this optimism, investors should focus on the only pure play – Market Vectors Steel ETF (SLX - ETF report) – which tracks the NYSE Arca Steel Index. The ETF has amassed $111.3 million in its asset base while trade in moderate volume of roughly 73,000 shares a day. The product charges 55 bps in fees and expenses from investors.

In terms of performance, the fund is still down over 10% in the year-to-date time frame and is underperforming the broad market fund and other products in the materials space by wide margins (read: 6 ETFs Beating the Market Over the Past Year).

However, SLX added nearly 10% in the past two months and is expected to move up in the coming months, based on both technical and fundamental factors described below:

Technical Look

Although the fund hasn’t broken out of its near-term range, its short-term moving averages have managed to stay above long-term levels. The 9-Day SMA is now comfortably above the longer-term 50-Day SMA and is rapidly approaching 200-Day SMA, suggesting continued bullishness for this ETF.

Additionally, the fund is trading near its resistance level of $44. Crossing this level will show a clear strong uptrend. This is further confirmed by an upswing in Parabolic SAR, although this figure should definitely be monitored closely (see more in the Zacks ETF Center).

Fundamentals

 

The fund provides exposure to a small basket of 27 stocks and is highly concentrated in its top 10 holdings with more than 68% of assets. This suggests that company specific risk is high and the top 10 firms dominate the returns of the fund.

 

The two top firms – Rio Tinto (RIO) and Vale (VALE) – take the largest share in the basket with at least 12% each. These two firms surged in double digits over the past two months, part of the reason for the rally in the steel ETF (read: Steel ETF Investing 101).

The product primarily focuses on large caps as it accounts for roughly half of the assets while mid cap takes the remaining share with a small allocation to small caps at 17%. In terms of country exposure, the U.S. takes the top spot at 38.2% while Brazil, Luxemberg and United Kingdom round off to the next three with 21.2%, 17.3% and 13% share, respectively.

To sum up, the steel ETF could be a good choice for investors given an improving steel outlook as well as strong technical and fundamental perspective.

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