China continues to pressure the commodities complex. After a well flagged run by commodities by us, we are offering investors a chance to at least trade the range, or possibly set up defensive positioning for escalation in markets that could get worse. Add in the lurking US Dollar which has been in a weakening more since the end of the first week of November, and you have another pressure point for commodities. Here is the trade:
Trade Idea: Short XLB
The XLB is the materials ETF that focuses on the following industries: construction, chemicals, containers, and packaging. Key holdings are: DuPont, Lyondell, Freeport Mac, and Dow Chemical.
The XLB hit an all-time high last week that surpassed the pre-crisis level of May 2008 when commodity prices hit their peak and US housing markets were on the edge of a cliff.
We outline three ways to trade:
- Short XLB with a target of $45.50. Consider this tactical in the context of the Chinese weekend and what we are seeing copper. This takes you back to the 20mda which is a resting spot before we could see re-acceleration in sentiment
- Short XLB with a target of $44.00. This would be an 8% pullback from the highs and take you just below the 50mda where ETF has respected but broken 3 times in the last 6 months. $44.00 has been resistance and support since September ’13 and is a clearly defined level closing within 50bps of $44.00 25 times in the period.
- Short XLB with a target of $42.00. A move to $42.000 is a 12% pullback from the top and represents a key level just below the 200mda where the XLB has also respected on the downside numerous times. $42.00 is the level that leads you back to May 2013 highs for markets before the “taper tantrum” and also marked a period where markets were not pricing in risks, similar to what we see today.
- We would be comfortable putting a stop on this short at $49.20 which would be a level 15% above the 200mda and overbot relative to other periods during the current bull market run.
- $49.00 is a tight 3% loss from today’s levels and seeks not to fight what has been rebound in PMIs for 25 months. This trend until otherwise proven over has been powerful and the force behind the move higher in materials.