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Sunday, March 2, 2008

The Iron Is Hot ! ?



THE STRIKING PRICE ( BARRONS )
Steel's Rally Is Just Beginning

FEW WORDS IN STOCK-RESEARCH notes are more pleasing to the eye than "structural imbalance," a phrase increasingly associated with the steel market. Despite steel's epic advance, Credit Suisse believes prices are headed higher. Key facts include:
• Demand has grown faster than supply for each of the past six years. • Global inventory is low, and "buying acceleration" seems to be occurring. • Steel prices are up more than 40% since October, which David Gagliano, a Credit Suisse analyst, recently told investors was "the beginning, rather than the end of the price increases in the U.S. steel sector over the next six to 12 months."
Investors who want to leverage this bullish view can trade customized stock baskets, like one offered by Credit Suisse, or avail themselves of listed products like the Market Vectors Steel Index Fund (ticker: SLX), an exchange-traded fund that delivers 30 steel stocks. Top holdings include Companhia Vale do Rio Doce (ticker: RIO) American depositary shares, Arcelor Mittal ADS (MT), Rio Tinto ADS (RTP) and Posco ADS (PKX). SLX's options barely trade -- so be careful trading the product.
Investors comfortable with single-stock risk should consider Nucor (NUE), a North Carolina steel company whose stock is up 27% in the past six months. From 2002 to 2007, Nucor's sales increased more than 245%, as the average sales price per ton more than doubled to $723 in 2007.
Credit Suisse rates Nucor Outperform, and on Tuesday increased its 12-month price target to $80 from $75 (it was $64.5 on Friday.) Also, Nucor's 2008 earnings estimate was upped to $6.18 from $5.93, and to $6.95 from $6.15 in 2009. Gagliano, the analyst, believes the stock is "structurally undervalued based on our view [that Nucor] has sustainable earnings power of $6 to $7 per share beyond 2008 and 2009."
To super-charge potential returns, Sveinn Palsson, a Credit Suisse derivatives strategist, likes buying Nucor stock, and a "1x2" call spread. His trade entails buying one January 70 call and selling two January 85 calls, all expiring in 2009.
"The good thing about this trade is that if you just bought stock, it would have to go high up to get a 45% return," Palsson said. "This way, since there's double leverage, the stock doesn't have to go that much higher to get such a high return."
The double-leverage comes from owning the stock and buying an at-the-money call, which Palsson said doubles returns up to $85. The trade is financed by selling two options at $85, which offsets the expense of buying a call with nine months to maturity, which can be expensive.
A risk to the bull thesis on steel is that steel prices increase against limited supply, causing "demand destruction." But the risk seems worth taking. As Citigroup's steel analyst advised investors Friday, an analysis of spot prices and 2008 earnings suggests the greatest potential earnings upside for Nucor, Freeport McMoRan (FCX), Alcoa (AA), Teck Cominco (TCK), and U.S. Steel (X). A "melt-up" seems more likely than a meltdown.

by STEVEN S.

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