Pan: Materials Select Sector SPDRs (XLB)

Research: 
XLB follows the smallest S&P 500 industry sector; materials. While this area represents just 3.51% of the S&P's sector weighting, it's delivered  a big time 41% year-to-date gain, which is bested only by technology stocks (XLK).  Materials includes companies like chemical makers, construction materials, forest products and paper and metals and mining. Top holdings include Monsanto (13.30%), Dow Chemical (9.33%) and Freeport-McMoRan Copper & Gold (9.33%). According to AltaVista Research, 2009 estimated earnings per share (EPS) of $1.12 are dramatically lower compared to $2.36 last year. Based upon this year's earnings estimates, materials have a P/E ratio of 29.1 - the highest of any S&P industry sector.  Much of XLB's upward move has not been because of a return to solid business fundamentals, but it's been due to a depressed US dollar, high commodity prices and expectations of inflation.

Opinion:
The materials sector has been one of the major beneficiaries of rising commodity prices. Towards the end of November, commodity buying has been mainly focused on gold just as equity buying was mainly focused on blue chips. Only the safest of investments would do. Last week saw a number of metal and mining stock buying climaxes: Newmont Mining, Anglogold, Goldcorp, Golden Start Resources, Iamgold, Lihir Gold, Randgold Resources, Royal Gold, Vista Gold, Yamana Gold. Notice the common denominator - gold. The spot price itself had a buying climax itself after reached a new all-time high of $1,227 last Thursday. Today (12-9-09) gold closed at $1,135. A rising US dollar (see below under "UUP) and falling commodity prices foreshadow a grim future for equities in general and the materials sector in particular. The UltraShort Basic Materials ProShares (SMN) is the only ETF to provide short exposure to the materials sector. With its 2x leverage, SMN may not be suited for conservative investors. Aggressive investors however should be richly rewarded for any short-term losses the topping process may cause. Today, SMN trades around $9 a share. A year ago, SMN sat at a lofty $70. While $70 is likely to be too high of a target price, we believe that SMN will rally towards $20 in 2010.

Prior ETF Pick Review: 
UUP: Contrary to the general consent, we've been expecting a dollar bottom since July, as expressed in the 7-30-09 Pick on UUP. Nevertheless, the greenback stayed soft throughout the summer which fueled the longer than expected rally in stocks and precious metals. After searching for a bottom most of November, it seems to have found it on 11-27-09 at an intraday low of 74.21. This week's rally pushed the US Dollar Index above the trend channel from the secondary June 2009 highs. Borrowing dollars to buy equities has become a popular thing to do. Many traders committed to this carry trade, should soon feel compelled to close their short positions and buy the dollar which will ultimately translate into a powerful dollar rally and equities decline. The dollar's push is still in its infancy, so some caution as warranted, nevertheless it looks like it will be up from here for the greenback.                                 << continued on next page







GLL & ZSL: There was a 3-day lag between the dollar's 11-27-09 bottom and gold's 12-3-09 top. Gold's reversal since however has been nothing but spectacular - down $100 in four days. Silver too has dropped more than 10% in four days. As the chart to the left shows (monthly gold prices since 2000), gold's high (we used the intraday high for December as December's reading) coincided with the upper range of a multi-year trend channel and would be a reasonable place for a top that is likely to last more than a year.
USO: The 6-11-09 Pan on USO stated the following: "Currently at $72 a barrel, oil may attempt to push towards, perhaps even past $80 a barrel over the next few weeks/months. At those levels, the best profit opportunity will come from shorting oil contracts directly or owning short oil ETFs like the UltraShort DJ AIG Crude Oil ProShares (SCO)." Crude oil did briefly spike above $80 in the second half of October and has since fallen to $71/barrel. It might be prudent to lock in gains with a trailing sell stop around 3-6% above $71 and subsequent lower lows.
Short ETFs: The market seems to be in the late stages of this rally, or early stages of a major decline. Aggressive investors may buy short ETFs between current prices and S&P 1,125 with a 3-4% stop-loss. Cautious investors may want to wait until the S&P closes below 1,040 (9,500 for the Dow), or rallies again above 1,115. Refer to the Market Meter below for more short-term guidance.
Cash: Cash continues to be the preferred choice for investors who don't trust the market at this time. Page 5 of the August newsletter and last week's pick (11-25-09) highlights the benefits of cash.

Market Meter:

    

While precious metals have broken their uptrend, the general trend for stocks has yet to be broken. The S&P remains within the 1,090 - 1,110 range it has essentially been confined to since October 14th. Declines to 1,090 have been followed by a subsequent stab above 1,100 for six times over the past seven weeks. Today's (12-9-09) Investor Intelligence survey showed a further drop in long-term bears to 16.5%, a 6.5 year low. More interestingly though, the percentage of advisors who expect a short-term correction jumped to 35.1%, the highest reading since March 1992. We've come to experience that the market usually does the unexpected. As such, we wouldn't be surprised if the market does not deliver on the short-term pull back and will surprise investors with another short-term rally towards 1,125 followed by the steep decline we've been expecting. Micromanaging the market's daily nuances has been challenging, to say the least, but we remain confident that this short-term uncertainty will soon be overwritten by broad-based selling, whether it will start right about now or in a couple of weeks.