An electric arc furnace used for recycling scrap metal back into steel products. Source: Library of Congress via commons.wikimedia.org.
There are two main points that explain how important iron and steel is to the world. The first is that an entire period of human history is known as the iron age, which ushered in the widespread use of steel. The second one is that Billy Joel wrote a song about it. Some will argue that the first one is far more important, but that's debatable. Either way, the manufacture of steel has been a critical cog in our development as a society for hundreds of years, and it will continue to be as long as we like to have the comforts such as a car to drive, roads and bridges on which to drive those cars, or buildings to work from. This makes steel a pretty intriguing investment for those looking for a long-term investment.
OK, so maybe the lyrics of "Allentown" might not give the best portrait of an industry you may be considering for an investment, but the iron & steel industry has changed a lot since then, and there are several opportunities for investors in this space for those who search out the right opportunities. Let's take a quick look at the iron & steel industry, what makes it tick, and what investors should look for when investing in this industry.
What is steel & iron?
Iron Ore mining operation. Source: University of Texas.
Steel is one of the backbones of the industry. It has been used for thousands of years because it has good tensile strength and hardness while having a low enough melting point and is malleable enough that we can cast and form it. It also helps that the primary ingredient in steel -- iron -- just happens to be one of the most abundant elements on earth. Steel is manufactured by reducing raw iron ore in a blast furnace to remove impurities and then incorporated with alloy materials such as carbon, manganese, chromium, or nickel to give it the desired characteristics.
The iron & steel industry is anything related to the manufacture of steel. It can be the mining companies that dig for the raw iron ore, alloys, or coking coal -- the primary fuel used for smelting -- or the mills that manufacture the steel by either processing the ore or recycling scrap steel back into usable products
How big is the steel & iron industry?
When you add together the mining companies and the steel manufacturers, the entire industry is composed of hundreds of companies with a market value north of $600 billion. That being said, the majority of mining and production of steel is done by a handful of companies. Annual production of steel is north of 1.5 billion tons per year.
One thing to keep in mind, though, is that many of the mining companies that supply iron ore are normally diversified mining companies that also extract other metals such as copper, aluminium, gold, and diamonds. Also, many of the suppliers of metallurgical grade coal -- also known as coking coal -- also manufacture lower-grade thermal coal used mostly in electricity generation.
A steel mill. Source: Jesper Schoen via commons.wikimedia.org.
How does the steel & iron industry work?
Let's break up the industry into its two primary components: the miners of the raw materials, and the manufacturers of the steel. Miners extract the raw materials and sell them to manufacturers on either long-term supply contracts or potentially on the spot market. The manufacturers, on the other hand, produce the steel, and the type of steel can vary based on their target market. For instance, some steel manufacturers specialize in making smaller amounts of high-quality steel or special steel alloys for particular needs such as the automotive industry, while others may be diversified steel manufacturers that churn out both large quantities of the most common product, carbon steel, and other specialty alloys.
The primary customers of the iron & steel industry are infrastructure, construction, automotive, and oil & gas.
What drives the steel & iron industry?
I could simply say China and be done with it, but let's dive into it a little more than that. China consumes about as much steel as the rest of the world combined, with India and the U.S. in second and third, respectively. The massive demand from both China and India is related mostly to their rapid economic growth and their large, heavy industry footprints. The steel industry and all mining activity related to steel pretty much rides on the coattails of Chinese economic growth and infrastructure spending. So, investors interested in this industry can normally use the health of the Chinese economy as a rough guide to the performance of those in the space.
Steel can be a pretty cyclical business, but long-term investing in steel is almost equivalent to a bet on an expanding economy. Infrastructure spending between now and 2035 is expected to be in the tens of trillions of dollars, and steel will be a large part of that market. Add to that the fact that demand from automotive and oil & gas will continue to grow over that time period, and steel investments look pretty compelling.
