Orderly Rally For Steel Dynamics Over The Last 7 Months May Be Slightly Overdone

Orderly Rally For Steel Dynamics Over The Last 7 Months May Be Slightly Overdone

Industrial metals have seen their prices shoot up over the last six months or so. Copper prices have shot up very rapidly, while aluminum and steel prices have also rallied. Not surprisingly, we have seen some pretty impressive rallies from the stocks in these industries as well. Several copper miners have seen their stocks double in the last six to eight months.

The rally in steel stocks has been more orderly and not quite as extreme as what we have seen from copper stocks. One particular steel company that caught my eye was Steel Dynamics (STLD). The stock bottomed at $14.53 back in March and recently hit a high of $38.64.


What has impressed me the most about the rally is how orderly and steady the trend has been. The trend line that connects the lows since May has been very consistent. If we use that as the lower rail of a trend channel, the stock is getting close to the upper rail at this time.

We also see how the 10-week RSI just moved into overbought territory, while the weekly stochastic indicators have been dancing back and forth across the 80 level. The stochastic readings being above 80 don’t bother me all that much, but when we look at the last three years, the RSI hasn’t stayed above 70 for very long.

I drew the horizontal line in the $34.50 area in order to show how that price level has come into play in the past. Back in 2017, the stock had a hard time moving above that price before breaking through in the fourth quarter. The price would come into play again as the stock hit resistance there in the fourth quarter of 2019. Now that the stock has moved back above the $34.50 level, I wouldn’t be surprised to see it act as support now. If we were to see the stock drop slowly over a few weeks, we could see the lower rail of the channel and the $34.50 area intersecting to provide a couple of layers of support.

The Fundamentals aren’t as Impressive as the Chart – at Least Not Right Now

As with most industries, the steel industry has been hurt by the global health crisis, and Steel Dynamics has seen its earnings and revenue drop as a result. Even before the health crisis hit, many companies in the steel industry were struggling as the trade war between the U.S. and China had taken a toll.

Steel Dynamics has seen earnings decline by an average of 2% per year over the last three years, while revenue has grown by 1% per year. In the third quarter of 2020, earnings dropped by 26% compared to Q3 2019, while revenue was down 8%. Analysts expect earnings to decline by 18% for 2020 as a whole, while revenue is expected to fall by 9.8%.

Looking out to 2021, earnings are expected to grow by 7.6%, and revenue is expected to increase by 8.4%. These expected increases are based on the company’s outlook, but they are also based on the global economy recovering from the health crisis. We have seen steel stocks and the materials sector as a whole jump sharply when the successful vaccine trials were announced. Obviously, the successful vaccines are a great thing for the world population and for the global economy. However, we could be seeing a little too much enthusiasm in certain areas.

I recently wrote an article for another website where I specifically expressed my concern about copper. My concern was based on the extreme bullish sentiment we are seeing on the Commitment of Traders report. Large speculators have recently built a net long position of over 67K contracts. Over the last five years, there have only been three previous instances where the group had such a large net long position, and in each case, we saw a decline in copper prices. The last time we saw such a big bullish position on copper was in June ’18 when the price of copper was hovering right at $3.30. The price would initially drop below $2.60 before rallying back a little and then eventually falling to $2.00 in March.

It may seem strange to spend so much time discussing copper prices in an article about Steel Dynamics, but the two have shown a pretty high correlation in the last three years. The same can be said for the Materials Select Sector SPDR (XLB). We expect the Materials SPDR to be highly correlated with copper prices, but not necessarily with a steel company.

I do think steel companies will see improvement in their earnings and revenue as the global economy starts to run at an increased pace. I also think companies like Steel Dynamics will see improvement with the new Biden Administration. The trade war took a toll on steel companies as the tariffs that were put in place by both sides hurt producers. The new administration has expressed an interest in using negotiations to induce change rather than using tariffs.

Sentiment Toward Steel Dynamics is Skewed Slightly to the Bearish Side

When I saw the rally in Steel Dynamics and looked at the extreme bullish sentiment toward copper, I was a little worried that I would find extreme optimism toward the stock. Instead, I found more neutral readings from the sentiment indicators. The short interest ratio is at 2.71, and that is just a little below the average of 3.0. The ratio was skewed to the pessimistic side back at the end of August with a reading just below 4.0, but has declined slightly in recent months. The short interest is at a similar level as it was in August, but the average daily trading volume has increased by almost 50%. That’s where the decline in the ratio has occurred.


There are 11 analysts covering Steel Dynamics at this time with five “buy” ratings, five “hold” ratings, and one “sell” rating. This gives us a buy percentage of 45.5%, and that is well below the average buy percentage. This means analysts are less optimistic about Steel Dynamics than they are the average stock.

STLD Analysts Ratings.jpg

Like the analysts, options traders are a little more pessimistic toward Steel Dynamics than they are the average stock. There are 14,759 puts and 10,164 calls open at this time. This gives us a put/call ratio of 1.45, and that is well above the average ratio. This is another indication that investors are more pessimistic.

When we look at the three sentiment indicators, with one in the average range and two showing more pessimism, it’s important to remember that I view these indicators with a contrarian view. Seeing pessimism directed at the stock is a good thing – especially when we see the stock rallying the way it has. The bearish sentiment means there are still investors that can switch to a bullish stance and that can help sustain the rally.

My Overall Take on Steel Dynamics

The chart for Steel Dynamics is a definitely plus for a bullish posture, but I am a little concerned about the 10-week RSI hitting overbought territory this past week. I wouldn’t mind seeing the stock pull back a little or go through a consolidation phase where it drops slowly over a few weeks – just enough for the stock to drop down out of overbought territory and maybe pick up support at the $34.50 level.

The sentiment toward the stock is also encouraging because investors and analysts haven’t gotten out of hand with optimism. This leaves room for the rally to continue as investors can switch to a bullish posture, and it leaves room for upgrades from analysts.

My biggest concern about Steel Dynamics is the fundamental picture. I expect the fundamentals to improve in 2021 as the global economy starts to rev back up, but I don’t know if the economic recovery is going to happen fast enough to justify the rally in the stock price.

Steel Dynamics doesn’t meet the minimum fundamental requirements I have for the recommendations I make in the Hedged Alpha Strategy, but I can see the stock continuing to move higher in the next nine to 12 months. We may see the trajectory of the rally change as we start to get a better look at how the vaccines help the economic recovery. I can see the stock getting back up to the $45.00-$47.50 range toward the end of 2021. From there, the fundamentals will need to change dramatically – earnings and revenue growth will have to be in the double digits to keep the stock moving higher.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Credit: SeekingAlpha

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