This beaten-up sector is poised for a breakout

One sector that has missed the broad rally over the past few years may be a leading candidate for a comeback.

That's right—forlorn steel stocks may be on the verge of breaking out.

While some of its individual components have performed decently, the ETF tracking the steel sector (trading under the ticker symbol SLX) is up only 4 percent over the last five years. That's abysmal compared with the benchmark S&P 500 index, which is up 94 percent during that same period.

Top 5 holdings in SLX



5-year returns




Rio Tinto






Steel Dynamics






But now that the price of a major input—iron ore—is trading at half of its peak level set in 2011, steelmakers may be poised for a comeback. And it could come at just the right time for investors.

(Read: Steelmakers lead as euro zone shares extend ECB rally)

"In a market where … a lot of stocks are at or coming off of 52-week highs, there's the constant quest to find the best catch-up trade," said Ari Wald, head of technical analysis at Oppenheimer & Co. "And our favorite catch-up trade here is in the metals and mining group."

Within that group, Wald likes steelmakers. "In 2011 and 2012, it suffered some very big losses but we're seeing those losses are beginning to stabilize," he said. "Prices are beginning to stabilize. Buyers are beginning to come in. This gets us interested. We think it is set up for a reversal higher."

Wald is particularly watching the $51 level in the SLX as key resistance, with a move above that level leading to a major breakout. The ETF hasn't traded above that price since 2012.

(Read: Survival of the fittest in the new iron age: Andy Home)

"I think you could buy that ahead of the breakout, because the [SLX] is above its rising 200-day moving average," Wald said. "If you get the breakout, it would measure to $66. That's the height of the base projected from the breakout point. That's my upside; I'm wrong if you can't hold $48 support."

The fundamentals for the steel group are also pointing toward a "buy," according to portfolio manager Chad Morganlander of Stifel Nicolaus' Washington Crossing Advisors.

"As a value investor, we would find this attractive," Morganlander said. "This is a global growth story here. If you believe that global growth is going to accelerate, then you buy the steel ETF."

That growth will come particularly after 2014, said Morganlander. "You're going to start seeing a lot of fiscal stimulus kick in within the euro zone as well as on the emerging markets side," he said. "And the United States is going to grow around 3 percent. So we would be bullish on steel. We would be a buyer of it on any weakness."

To see the full discussion on the steel sector, with Wald on the technicals and Morganlander on the fundamentals, watch the above video.

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