The best ways to play the Olympics steel boom

Tokyo is seeing something of a crime wave. These days, you never know what's going to disappear overnight: the list of things nicked from the city's streets has recently included pavement gratings, electrical cables and even the occasional playground slide. So what's going on? Police say thieves are spiriting all the scrap steel they can find away to Yokohama, where it is loaded on to ships and taken to Beijing. Here, this highly sought-after (and handsomely paid for) commodity is used to feed the Olympic construction boom.

Global steel demand has risen 6% a year since 2000, thanks in large part to the huge boom in demand from China (where, to give just one example of where the steel goes, 108 new airports are to be completed by 2010). But while China has accounted for well over half the rise and now uses 30% of the world's steel production every year, steel demand isn't just about China. Construction-driven demand has been rising at well above 10% a year in emerging markets such as Brazil, Russia, India (where spending on infrastructure is set to rise 40% this year) and the Middle East too, and that demand doesn't look like it is going to fall off any time soon. The International Iron and Steel Institute has forecast a rise in demand of 5.9% as their base case for 2007, but this is predicated on sharp mid-year slowdowns in the US, Europe and Japan, which, of course, may not happen. Even if it does, this may have little effect on demand levels in Asia.

The long-term outlook for steel demand is also encouraging: a recent report from Boston Consulting Group predicts that the worldwide steel industry will see growth of 3%-4% per year right through to 2015. You would have thought all this would be enough to make the City's analysts love the sector yet most of them are wary of it. China has quadrupled its steel output since 1996, and to them that's an expansion of capacity too far: China may be importing scrap from Japan, but it's also a net exporter of some kinds of steel products. Add in a possible downturn in US construction and the steel bears see a dangerous cyclical build-up of inventories on the way.

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Will steel demand last?

So, should we worry? David Fuller of Fullermoney.com thinks not. Chinese steel consumption is still rising fast (as it is all over the emerging world); US construction spending unexpectedly rose 0.3% in February; and the price of new steel has hit record highs in the last few months. At the same time, the price of scrap steel has risen up to 68% this year already, according to analysts at Citigroup. This hardly suggests there is even a hint of oversupply in the market, nor that there will be any time soon: note, says Citigroup, that the price of scrap has long been a reliable leading indicator for the price of new steel.

Another plus for investors in the sector is that it has started to see some impressive consolidation. The merger of Arcelor and Mittal last year created the largest steel firm in the world, and last week Mitsui said it was to buy Steel Technologies, one of the biggest steel-processing firms in the US. Consolidation has been good news for the sector over the last five years, says John Anton, director of Global Insight: it has created global firms that pack enough market power to exert an upward influence on prices and force long-term supply contracts on to their customers. All in all, says Fuller, the big steel companies look like they offer a good and right now, a very cheap way of playing the infrastructure boom. See below for the best ways in.

Two of the best stocks in the steel sector

As the largest company in the steel industry, Netherlands-based Arcelor Mittal (NYSE:MT) is well placed to play the global infrastructure boom, with a production capacity of more than 115 million tons and operations spread across 27 companies. Arcelor Mittal generates a large bulk of its income from operations in Brazil, central Asia and other developing markets. Furthermore, the recent acquisition of Arcelor provides Arcelor Mittal with very strong synergies and insulates the company against rising raw material costs. The shares are very attractively priced on a price/earnings ratio of 10.15 and yield of 2.47%.

Another steel company with bright prospects, and one that David Fuller of Fullermoney.com favours, is Nucor (NUE). The company is well positioned to make some windfall profits from the expansion of India and China, and is described as the most efficient and profitable steel company in the US by Citigroup analysts. Given the increasing power of US steel companies to influence prices, Nucor is in a position to take advantage of rising scrap prices. The company also has a very solid balance sheet and a reputation for returning cash to shareholders. The shares currently trade at an undeserved discount to their peers on a p/e of 11.14, says Fuller, and pay a healthy 4% dividend.