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Steel This Fund

If you want to add a little backbone to a portfolio that seems a bit weak, the Market Vectors Steel (AMEX: SLX  ) exchange-traded fund (ETF) provides a unique way to focus on infrastructure in one of its most basic forms: steel. Since its launch in October 2006, SLX has grown to $135 million in assets. The fund has generated a spectacular 47% return so far this year, making this nonprecious metal pretty special. However, since steel is subject to intense price competition and market volatility, along with governmental interference, tremendous returns are not something you should expect to experience all the time.

SLX can be looked at as another way to participate in emerging markets like China and Vietnam, where strong demand for steel is led by growth in autos, construction, and consumer durables. The fund has an expense ratio of 0.55% and tracks the Amex Steel Index, a modified market capitalization-weighted index comprised of companies involved in steel production and fabrication or mining and processing of iron ore. The index currently holds 33 stocks.

Three holdings make up nearly half of the index, with two of those coming in at nearly 15% each: Rio Tinto (NYSE: RTP  ) , an international mining company, and Companhia Vale do Rio Doce  (NYSE: RIO  ) , the world's No. 1 miner of iron ore. A 14% exposure to Arcelor Mittal Steel (NYSE: MT  ) , the largest steelmaker in the world, rounds out the index's top stocks.

BRIC and steel
Strong economic growth in developing areas, such as the BRIC countries -- Brazil, Russia, India, and China -- has driven up demand and the price of steel. With construction of roads, buildings, and bridges booming in these countries, steel is in high demand. Growing economies also mean wealthier citizens who demand autos and consumer goods containing steel. Most appliances and cars are approximately 65% steel.

Two themes
Consolidation and privatization have helped to drive stock prices in the steel business. These two forces have reduced the number of companies and are forcing the remaining players to be more bottom-line-oriented. As the sector consolidates, economic discipline is institutionalized, which ultimately may lead to higher stock prices. The dwindling number of companies may also drive prices up as investors pay higher multiples for the remaining companies.

Steel goes around
The base metals sector, including steel, is very cyclical, with large purchases coming during good economic times. With most economies well into their economic booms, and markets richly valued, if economic growth starts to slow, steel is likely to change from red-hot to cold rather quickly. Pricing pressures can also come from geopolitical tensions, government intervention, and supply shortages.

To steel or not?
SLX has had an excellent price run, and that performance is seductive. There are some very solid reasons why this fund has surged ahead. Keep in mind, though, that the company is very concentrated, both because it's in only one sector and because of the size of the index it tracks. This leaves it very dependent upon the whims of the steel business. For most investors, a more diverse approach to commodities is probably a better approach, but for those who can afford concentration and the risk that goes with it, this fund could make an interesting, but small, component of your portfolio.

Fool contributor Zoe Van Schyndel lives in Miami and enjoys the sunshine and variety of the Magic City. She does not own any of the funds or securities mentioned in this article. The Motley Fool has a disclosure policy.

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