The Real Reason Basic Materials ETFs Are Moving Lower

| January 29, 2010

The market’s been moving like Reggie Bush running for a touchdown against the Arizona Cardinals (man that loss hurt).  News headlines seeking to assign blame for the market’s recent pullback have focused on Washington DC.

You’ve probably seen it.  I’m talking about a Republican Senator from Massachusetts taking the seat formerly held by Democrat Edward Kennedy for 46 years.  Then there were questions surrounding Ben Bernanke’s reappointment as Fed chairman.  And to top it off, Obama came out and blasted the ‘too-big-to-fail’ banks.

These headlines seem unsettling.  But they’re not the real reason the markets are heading lower.  There’s a simpler reason.  Just look at the sector leading the markets since the March bottom.  It took a one-two punch to the chin.

The Basic Materials Industry is being pushed lower by China and the US Dollar.

You see, basic materials stocks have been the bellwether for the global economic recovery.  And that recovery is being led by China.

Remember, it took China’s targeted stimulus efforts to start driving demand while the rest of the world was still gripped with fear.  The plan worked and last quarter China’s growth was over 10%.

Now China’s Communist government has begun to restrict credit.  They’re tightening lending standards and raising reserve requirements.  That means less money is available to Chinese companies to keep their economy growing.

At the same time, the US Dollar has reversed its ten-month slide.

As long-time readers know, commodities like basic materials have an inverse relationship with the US Dollar.  As the US Dollar gets stronger, commodities traded in US Dollars become more expensive to foreign buyers.

Here’s the deal with the US Dollar.  Back in March of 2009, money flowing out of risky investments piled into cash.  It drove the US Dollar up to highs it hadn’t seen since 2006.  Then as fear began to subside, money began to flow out of the US Dollar and into riskier investments.

But now investors are focused on problems in other countries.  Just look at Greece.  They are part of the European Union and the fear is Greece may default on their sovereign debt.  That’s bad news for the Euro.

Basically, investors realized the US Dollar is better off than the Euro.  That triggered a reversal in money flow back into the US Dollar.

It’s looking like the beginning of a new rally for the US Dollar.  I wouldn’t be surprised to see the rally last most of 2010.

So with China dialing back spending and the US Dollar poised for a rally… obviously basic materials are going to head lower, right?  Think again.

Now is a great time to buy basic materials ETFs.  As Chinese demand fades, US demand is just getting ready to fire up.

Here’s why.  US Government Stimulus… you remember that $787 billion dollar stimulus plan, right?  (Who could forget it!)

Only $257 billion, or 33%, of the funds authorized have actually been paid out.  That’s government efficiency at its best!  So far it’s mostly transfer payments… stuff like additional unemployment benefits and aid for schools.

The money spent so far has focused on cushioning the fall.  The money designated for infrastructure projects and other economy stimulating purposes hasn’t been deployed yet.

But that’s about to change.  The majority of the stimulus package, $530 billion, is set to be distributed in 2010 and ‘11.  As these funds make their way to the private sector, demand for basic materials is going to skyrocket.

Now is the time to take advantage of other investors’ fears.  The two basic materials ETFs I like are the Materials Select Sector SPDR Fund (XLB) and SPDR S&P Metals and Mining Fund (XME).

 

Tags: , , , ,

Category: ETFs

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

Comments are closed.