Commodity-Linked ETFs Still Outperforming Broad Market

11/16/09 09:22:52 AM

by Donald W. Pendergast, Jr.

Compared to most other stock industry groups, commodity-linked ETFs are still standing tall. Are good trading opportunities still available here?

Security: KOL, GDX, SLV
Position: N/A

The broad stock market is down about 6% or so since making a high in September/October 2009, but stocks in the gold/silver/coal mining and steel-making industry groups are holding up well. In addition, commodity exchange traded funds (ETFs) that trade gold, silver, and copper are also doing very well, bucking the broad market downtrend. We'll look at the top-performing ETFs now (see Figure 1).

FIGURE 1: TOP-PERFORMING ETFs. Basic materials, emerging markets, and energy ETFs populate the top 10 ranking among 50 major ETF groups. This should prove to be a common theme for the next decade or more.

Graphic provided by: MetaStock.

Out of the top 10 list of ETFs, most of them hail from the basic materials sector (coal, silver, steel, gold mining, copper), the emerging markets sector (China small cap, China real estate, Vanguard emerging markets), and energy sector (oil services and equipment). We've seen this kind of scenario before, and I suspect it will be a common theme for some time to come — that is, the obvious connection between China's equity market (along with other major players like Brazil and India) and the ever-growing need for every kind of raw material, especially those from the basic materials, energy, and food sectors of the commodity markets.

Traders and investors looking to enter any of these hot ETFs might consider adding new positions on pullbacks (followed by a confirmed reversal, of course) toward each fund's 50-day and/or 50-week exponential moving average (EMA) for as long as they maintain high relative strength rankings. A more focused approach might be to pick the strongest individual stocks from each related ETF; for example, you could run a relative strength comparison between GDX and all of its component gold/silver mining stocks, looking to buy the best performers on pullbacks to strong support levels. For actual commodity-contract ETFs like SLV, GLD, and JJC, you need to be aware of the seasonality of each market (specialized seasonal charts are available from a variety of vendors), and it also wouldn't hurt to keep tabs on the current posture of the major players in the related futures markets, making sure that you're not taking an opposing position (especially a long-term investment position) against these big money commodity market interests.

There are many futures markets in which the commercial interests are holding record or near-record short positions, meaning that they see no fundamental reason to acquire commodities at current price levels. These commercial interests typically begin to buy as a selloff begins to gather steam, and they'll buy all the way down til the commodity begins to reverse higher. They have billions of dollars at their disposal, allowing them the luxury of scaling into their market positions. You and I probably don't have that same advantage, so we need to pay close attention to what they're doing with their funds.

FIGURE 2: THE REST OF THE ETFS. Natural gas, agriculture, livestock, long bonds, and regional banks area trail the rest of the ETF pack.

Graphic provided by: MetaStock.

Now, a brief look at the weakest ETFs on the list (Figure 2). Not surprisingly, the natural gas ETF (UNG) is lagging all of the others and by a considerable amount. Yet even this fund could be an outstanding scale trade situation at some point, and monitoring the futures market commitments by the big money traders will be one indication that it's relatively safe for the average trader to begin to dip their toes into this market. Surprisingly, the livestock (COW) and agricultural (DBA) funds are relatively weak; again, at some point these funds will likely become attractive buys for the smart money.

Regional banks (IAT) and long bonds (TLT) are also relatively poor performers. Overall, however, this relative strength ranking exploration paints a generally bullish image for portions of the stock and commodity markets, especially since only four of the 50 ETFs tracked have negative overall scores over the past 12 months. A major weekly cycle low is due within the next two weeks in the broad US markets, so it will be fascinating to see how this ranking begins to change again, should we see another powerful rally from that anticipated low into the New Year. Stay tuned for more action.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
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