Marketscope's Scoop on Steel & Gold

11/12/2015 9:00 am EST

Focus: COMMODITIES

Todd Rosenbluth

Senior Director of ETF & Mutual Fund Research, CFRA Research

An appreciating US dollar, excess global capacity due to weaker demand in China, and the influx of cheap imports has negatively impacted US domestic steel producers' market share and margins, observes Todd Rosenbluth in S&P Marketscope.

However, S&P Capital IQ believes there are a number of bright spots in the smaller metals and mining industry and equity analyst Matthew Miller believes the worst is over for steel producers and we see upcoming catalysts from pending trade case determinations.

He thinks that imports will revert back down to historical levels, allowing steel producers to benefit from a gradually improving construction market, impressive automobile demand, and an aerospace industry poised to experience a long-term secular uptrend

Meanwhile, S&P Capital IQ has three strong buy recommendations on US domiciled steel companies. Nucor (NUE) is the largest with a $13 billion market cap.

According to Miller, NUE's strategy to become more vertically integrated with its new Louisiana direct reduced iron plant, which will result in generally less volatile production costs. The new plant will enhance NUE's low-cost position in the US steel industry.

For the longer-term, he sees earnings rising on US economic growth, strong automotive demand, and a recovery in nonresidential steel demand and better control of raw material costs. S&P Capital IQ forecasts $3.18 in 2016, up from $1.67 in 2015, driven in part by 8% revenue growth.

Reliance Steel & Aluminum (RS) and Steel Dynamics (STLD) are the two other S&P Capital IQ strong buys in the steel sub-industry.

S&P Capital IQ views the fundamental outlook for the gold sub-industry for the next 12 months as neutral.

Miller thinks gold prices have several headwinds, including an appreciating US dollar, low oil prices, and decreasing inflation forecasts. However, he believes gold prices are likely to remain range-bound, as they have found support at, or near, the marginal supply cost.

Despite this take on gold prices, Miller also has a favorable view on S&P Capital IQ buy recommended Barrick Gold's (ABX) decision to prioritize cash flow and profitable production.

He thinks its efforts to reduce costs will further have a positive effect on earnings. S&P Capital IQ forecasts 2016 EPS of $0.65, up sharply from a projected $0.38 in 2015.

SPDR S&P Metals & Mining (XME), an approximately $300 million ETF, is the most direct way to get exposure to the industry. Steel (48% of assets), diversified metals & mining (13%), and gold (10%) were the three largest sub-industries.

For investors that want more exposure to gold miners, Market Vectors Gold Miners (GDX) is the largest materials ETF. GDX has $5 billion in assets.

Those interested in an actively managed mutual fund should consider Tocqueville Gold (TGLDX) and Vanguard Precious Metals & Mining Fund (VGPMX).

Both funds have lost less money than peers in the last three years, while generating lower volatility. VGPMX has the lower expense ratio, but TGLDX's management team has a longer record running the fund.

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