Should you invest in steel stocks now?

The steel industry is one of many sectors that have suffered collateral damage from the US Federal Reserve's rate hikes. Washington's hawkish monetary policy ensured that most commodity prices, steel included, were brought down from their post-pandemic peaks.

Interestingly, the market is displaying a sense of optimism towards steel stocks, even in the face of lower steel prices and lacklustre financials of steel producers. Most steel stocks are trading at an all-time high.

This peculiar trend warrants a closer look. So, here's our take on why steel stocks have turned D-street darlings.

The promise of rate cuts

The market anticipates the US federal government will relax its monetary policies in the coming quarters. The US Federal Reserve Chairman has mentioned three to four rate cuts in 2024. This has led to bullish sentiments around steel stocks.

To understand why, we must recap the relationship between the US dollar, US bond yields and commodity prices. The federal government increases interest rates on bonds to combat inflation. The US government bond is among the safest securities. So, when yields are high, a bulk of global capital flows into US bonds. This increases the demand for the dollar, and the currency appreciates.

However, a rising dollar means a weakening rupee. Simply put, if you were paying Rs 70 for $1 worth of steel (the US dollar is used for most global trade), now you have to pay Rs 80! But, the reverse happens when the federal government slashes its interest rates and bond yields drop.

The market anticipates that the rate cuts would lead to higher steel prices and higher earnings for steel producers. Historically, this has been the norm.

The China factor

China, the world's manufacturing hub, is the largest consumer of base metals. In recent years, Covid lockdowns and a real estate crisis have led to a slowdown in its economy. To spur a revival, China has lowered interest rates and reserve rate requirements for banks.

Note that the last time China provided a stimulus (this was post the 2008 crisis), it led to a bull run in commodity prices. D-street expects a similar outcome from the present relaxation of interest rates in China.

Should you invest?

The above factors hint at a surge in steel prices in the near future. In addition, domestic demand is also expected to maintain its upwards trend given the government's focus on infrastructure and capex.

However, there are certain factors you must consider before investing:

• Market prices: The market may have already priced in the anticipated demand increase. The current high prices of steel stocks may limit future gains.
  
• Industry cyclicality: The steel industry is known for its volatility. The demand outlook could be disrupted by geopolitical tensions or other external shocks. Investors should be prepared for potentially high volatility

Also, we have only covered the macroeconomic factors favouring the steel industry as a whole. Broader economic trends do not guarantee success for all steel companies. Investors should perform thorough research on individual companies to make informed decisions. The above are not stock recommendations.

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