From the desk of Steve Strazza @Sstrazza
Thanks to everyone for responding to this week’s Mystery Chart as always.
We had some great responses, most of which were mixed, with a slight majority wanting to “do nothing” and wait to see how price reacts at its former highs.
The chart was the Lithium ETF $LIT, which is breaking out to fresh highs along with a ton of other subsectors within the Materials space right now.
In this post, we will analyze almost every one of the key Materials industry groups to determine whether participation is broadening underneath the surface and supporting the recent strength and rotation into the sector, or vice versa.
Here’s the Lithium chart. It’s trading at fresh all-time highs and attempting to break out as I write this.
If we’re above 40.75, the bias is higher and we want to be betting on further upside and looking to this group for opportunities to express our bullish thesis on Materials.
What about the rest of the sector, though? Are other industry groups showing leadership as well?
Here’s a bubble chart comparing the very short-term performance (since the market peaked earlier this month) vs the longer-term trends (percent change from 2018 high on y-axis) of various Materials subsector ETFs and Indexes.
In the title, we pose the question: “Who Are The Leaders?”
Unless your answer is Gold Miners $GDX, which we wrote about earlier this week, so won’t touch on in this post… it really depends on the timeframe.
For example, subsectors such as Agribusiness, Chemicals, and Lithium have been about flat and underperforming Materials since September 2nd. Still, when you zoom out, you’ll notice these areas have been some of the sectors’ long-term leaders as they are all right back at their 2018 highs and attempting to break out of multi-year bases… quite similar to the action we just saw from the Materials Sector SPDR $XLB.
The reason why these groups are all smack in the middle of the bubble chart is that they’re back at their 2018 highs, although price is still trading right about where it was when the market peaked just over two weeks ago.
There’s nothing wrong with a little consolidation and digestion of recent gains, which is all this is. You can see this in the Lithium chart above, and the others which we’ll cover below.
Contrast this with areas like Rare Earth Metals, Uranium, Copper, Forestry, Steel, and Coal. These groups have all been secular laggards.
Just look at the drawdowns from their 2018 highs. These areas are all -20% to as much as -60% (REMX & KOL) below their highs from a few years ago.
But! There is a bigggg “but” here… In recent weeks and months, many of these groups have actually been outperforming and showing some serious short-term strength. Maybe it’s just mean reversion, or maybe it’s the beginning of something larger.
We won’t know until we have more data, but when “rocks-stocks” like Coal are up 5% while the S&P is down -6%, it can only be a positive for Materials as a group.
We’ll cover these areas later, but first let’s take a look at some of the leaders mentioned above.
Here is Agribusiness $MOO.
Beautiful multi-year base with momentum in a bullish regime as price consolidates in a range between its key 2018 and 2020 highs. As we like to say, the more times a level is tested, the more likely it is to break.
We think this one’s about to go. We want to own MOO on strength above 69 with a 1-3 month target at 85.
It’s worth noting, though, that while there are plenty of Materials components, the Agribusiness ETF has only a 20% allocation to the sector and is dominated by some large holdings such as Deere $DE and Zoetis $ZTS, which reside in the Industrials and Health Care sectors, respectively.
Here is the S&P 500 Chemicals Index $CEX now. Chemicals have been the strongest industry group within Materials for the past several years.
Notice the long-term primary uptrend coming off of the Financial Crisis lows. After multiple years of consolidating beneath our prior objective, prices just resolved higher. As long as we’re above 650, the bias is higher in this name and we’re targeting 955 over the next 6-12 months.
Let’s check in on some of those areas still trapped well beneath their 2018 highs now.
Here’s Rare Earth Metals $REMX, which is definitely a long-term laggard as you can see by its position way at the bottom of the bubble chart.
While this one has cooled off and moved lower in recent weeks, as illustrated by its position towards the left of the bubble chart, it’s still setting up nicely for a potential resolution higher. After rallying back to its Q1 highs last month, price has been flagging constructively as the slope of the long-term moving average continues to transition from flat to up.
This one definitely has the makings of a nice long-term reversal. If we’re above 45, the bias is higher in REMX.
To be clear, Rare Earth Metals are a long list of elements, none of which I can pronounce, and most of which no one has ever heard of. The bottom line is when we see a bid in obscure assets like these, it tells us a lot about risk appetite.
Here’s another space that the crazies like to hang out in. When even Uranium $URA is seeing investor interest, we know the animal spirits are alive and well in Equity Markets.
Another long-term downtrend working on a bearish-to-bullish trend reversal. Again, notice the moving average flattening and turning higher as price resolves above key former support and resistance. If we’re above 11.50, the risk is to the upside in Uranium stocks.
How about Steel? Let’s see how stocks like Rio Tinto $RIO, US Steel $X, and Nucor $NUE are doing these days. They are all top holdings of the Steel ETF $SLX, shown below.
While it sure isn’t the prettiest chart over the long-term, we just want to see some improvement from these laggards for now… and we are. Steel stocks have been stair-stepping higher off the March lows, resolving from one continuation pattern after another. They just broke out of a flag pattern to their highest level in almost seven months. As long as we’re above 31.50 we think Steel stocks keep trending higher.
Here are their cousins, the Copper Miners $COPX.
If you want to know what these guys are doing, just look at one of their largest components, Freeport-McMoRan $FCX. The two charts look almost identical as both just broke above long-term trendline resistance and resolved higher from nice bases. If we’re above 21 in the Copper Miners, expect this area to keep grinding higher.
Next is probably the worst of all when it comes to the structural trend. Coal stocks $KOL!? Yes, they still exist. Here’s the chart.
Coming off a logical level of support at its key prior lows from 2016, Coal stocks recently resolved upwards from their current continuation pattern to their highest level in over three months. We’re watching those June highs at 79.50 to see if price can sustain this recent breakout.
Last but not least, did you know there was a Forestry ETF $WOOD? Some of its largest holdings include Materials stocks like Westrock $WRK and International Paper $IP.
This is just another great looking base. Price is pressing right up against those key former highs from 2019 and earlier this year as we speak. We think the third time’s going to be the charm. If price is above 67, the bias is higher in WOOD. We’re targeting 84 over the next 2-4 months.
So, what’s the major takeaway from all these charts?
The fact that even the weakest areas of Materials are trending higher over short and intermediate timeframes is incredibly constructive for the sector at large.
While we don’t so much want to use these weak areas to express our bullish thesis, we do want to use them to help build and confirm our thesis. What I mean by this is that there are stronger stocks in stronger areas such as Chemicals, Agribusiness, and Gold & Silver Miners. That is where we want to focus for long opportunities.
But the fact alone that these long-term underperformers are now participating to the upside only bolsters and supports our already bullish view on the entire Materials space.
Whether it’s long-term leaders breaking out of bullish bases to new highs, or the long-term laggards showing near-term strength and resolving higher from continuation patterns, the message of the market is very clear… the recent strength from Materials is being supported by an expansion in participation and overall healthy internals.
As such, we continue to favor the sector and anticipate more outperformance from it over the long-run. Do you think we have this right?
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