Has This Once Red-Hot Metal Cooled Off for Good?

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Investors can choose from thousands of exchange-traded funds that offer a wide variety of different types of stock market exposure. From the broadest possible coverage to the narrowest focus, ETFs are available to meet just about every investor's needs.

One of the hot-button areas in the global economy in the past month has been the steel industry. After years of terrible performance in the construction industry, low steel prices hurt steel producers, crushing their stock prices. Recently, though, calls for the U.S. to expand infrastructure spending helped steel stocks start to recover, and steel became the initial chokepoint for what many people now fear could escalate into a full-blown trade war between the U.S. and some of its biggest global trade partners. All those issues have caused VanEck Vectors Steel (NYSEMKT: SLX) to move sharply in both directions at times over the past year, and although the ETF is still up double-digit percentages over the past year, it has given up substantial gains in the past month that some believe signal another period of underperformance for the broader steel industry.

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Why steel's been in the news

The reason why so many people are looking at the steel industry is that the White House chose the building material to be one of its first proposed tariffs. When the Trump administration imposed a 25% tariff on imported steel in early March, domestic steel stocks surged in the hope that they'd be able to get more demand at more favorable prices to boost profits.

However, the reaction in the international community to the new tariffs was extremely negative, and major trading partners objected to the unilateral decision. In response, the White House carved out new exceptions for more countries, going beyond initial exemptions for Canada and Mexico and also adding to the list of accepted trading partners Australia, Argentina, Brazil, South Korea, and the members of the European Union. That caused steel stocks in the U.S. to give up most of their gains from when the tariffs had initially been announced.

Know what you're investing in

Another important factor to understand involved what ETFs invest in. Many investors mistakenly believe that because a fund is sold on a U.S. exchange, it won't hold shares of foreign stocks.

That couldn't be further from the truth in the case of the VanEck Vectors Steel ETF. The steel ETF holds more than two dozen stocks in the steel industry, but they span the entire world market. In fact, you have to go all the way down to the ninth-largest holding in the fund before you get to the first American player in the industry.

Part of that has to do with the makeup of the fund. The VanEck Steel ETF doesn't include just steel producers but also some of the companies that provide key raw materials for use in steel production, such as iron ore and metallurgical coal. With far more than half of the fund invested in companies that are not U.S. steel producers, investors are in for a shock if they assume that investing in the ETF's shares will let them enjoy the ups and downs of the American steel industry.

Can steel harden up?

The other thing that would-be steel investors need to remember is that not all steel stocks are alike. Nucor (NYSE: NUE) has done exceptionally well over the past year, largely because it prepared for the inevitable cyclical uptick in steel by making smart investments in its business and shoring up its financial condition.

By contrast, some believe that U.S. Steel (NYSE: X) could have trouble even if tariffs remain in place. In the past when tariffs on steel were imposed, U.S. Steel actually saw its shares hit highs before the duties became effective. Once they went into effect, share prices fell. The problem: When steel prices get artificially elevated, it leads those who purchase steel to look for other alternatives. That could have exactly the wrong impact on U.S. Steel.

What happens with tariffs and trade in the long run is anyone's guess. For now, investors in steel face a lot of uncertainty, and so it's reasonable to expect continued volatility in the months to come.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends Nucor. The Motley Fool has a disclosure policy.