Although they took most of the summer/fall off, ignoring the uptrend that most other sectors enjoyed between July and September, the basic materials stocks look like they're finally ready top get moving again. There's no doubt this is a higher-risk call than our usual opinions. We're only at the early stages of what may not even really be a breakout. However, so far, we like the bullish technicals we've seen.
After peaking at 248.27 in May, like many indices did, the Dow Jones Basic Materials Index (DJUSBM) did nothing but fall the next four months. The problem was, the market didn't really slide longer than two months - the basic materials stocks were falling on their own between July and September. The failure to recover had many traders wondering (and us too) if the party was over for this sector, especially in the shadow of such a strong run in early 2006.
As of mid-October though, the Dow Jones Basic Materials Index looks like it may be coming back to life. We've seen a cross back above the 50-day moving average line (purple) as well as above the 200-day line (green). And more than that, we've seen some nice upside follow-through to suggest the rebound is for real. That in itself isn't overly telling. However, when we've seen this overall scenario in the past, it was usually on front of a bigger bullish push.
Specifically, we now have a complete MACD crossover. Of the last five we've had (highlighted with yellow), only two of them we're errant, and could have been quickly canceled. Of the three that were good, two of them were outstanding, as they set up the monster runs in 2004 and 2005. The MACD crosses that coincided with a relatively-recent cross above the 200-day line were particularly effective. Adding to the upside potential is the idea that we're coming out of a stochastically-oversold situation. Both of the major rallies we see on the chart were jump-started after a fairly lengthy period of weakness.
As we said above, the odds of this breakout getting any traction are a little less than we'd normally like. But, if it does, the potential payoff is much bigger than usual. The tentative target is 268, with a closing stop under the 50-day line, currently at 217. Be sure to look at the chart of the index below, but keep reading for a special focus on the steel companies - one of the key components of this sector.
By the way, there's an ETF for this sector, the iShares Basic Materials Fund (IYM). Some of the major individual company names in the sector are Phelps-Dodge (PD), Exxon-Mobil (XOM), Dow Chemical (DOW), Teck Cominco (TCK) and Barrick Gold (ABX). (continued below)
Dow Jones Basic Materials Index (DJUSBM) - Weekly
What's fueling the recovery for basic materials stocks? Some would argue the increase in oil prices again. However, a closer look at crude futures reveals that oil prices are still in a downtrend - not in an uptrend. We've just seen an occasional bounce in oil over the last few days, not enough to shift its overall momentum.
No, the bulk of the new basic materials uptrend, so far, has been provided by the steel companies. The Dow Jones Steel Index (DJUSST) was up 4.62% last week, and is up by more than 17% for the month. And, there may be plenty more of the same on the way. Once the steel stocks get started, they can really move without looking back. Just look back to 2004 and 2005 for examples, those two moves were made with amazing consistency.
In fact, the MACD and stochastic buy signals for this index are even better defined and more predictable than with the sector chart. The target (an aggressive one) here is 410. Stops on this bias come with a close under the 200-day line, currently at 261.
Major stocks in this index include Nucor (NUE), Mittal (MT) and POSCO (PKX).
Dow Jones Steel Index (DJUSST) - Weekly
Price Headley is the founder and chief analyst of BigTrends.com.