Why I’m Bullish This Materials Select Sector ETF (XLB, DD, MON, NEM, FCX, DOW, UYM)

David Gillie: No matter what happens, Basic Materials are needed for the job. Whether its flak jackets and gun powder for war, agriculture chemicals and pesticides for farming or coatings and ingredients for pharmaceuticals, Basic Materials are needed. Yes, even embalming chemicals and casket materials for death—XLB has it covered.

Basic Materials is the second derivative for nearly everything. We’ve recently seen a rally in the homebuilders. Although they may not be building homes per se. They’re building apartment buildings, converting condos and remodeling homes. All of this work requires copper for plumbing, paint for walls, adhesives for flooring, synthetics for counter tops and plastics for appliances. Biotech has also rallied. Pill coatings, capsule casings and compressed gasses and plastics are needed in the manufacturing of pharmaceuticals. Agriculture is showing signs of a new rally. Farmers are now scientists having to use the precise chemical blends in fertilizers and pesticides to maximize crop yields.

If the economy is showing the first signs of baby steps into growth, Basic Materials is the first wave of cyclical recovery. Further encouragement was the Fed announcement on Wednesday hinted toward some relief in underwater mortgages and extended low interest rates through late 2014. The focus is a stimulus of the housing sector. This is good news for Basic Materials.

Another factor of Basic Materials is that companies try to operate out of existing materials in times of economic slowdown. Supplies dwindle to minimal inventories. At the first light of recovery, inventories must be replenished before the thick of the growth cycle so they are on hand as needed.

Materials Select Sector SPDR (NYSEArca:XLB) holds the best of breed in Basic Materials producers.

The DuPont Company (NYSE:DD) is the undisputed king of Basic Materials. From the 2009 rally, DuPont was the top performing Dow component. Started as a gun powder manufacture supplying the US military in WW I, DuPont became most known for its development of Nylon in the 1950’s. From there it branched out in multiple directions of chemical production. Kevlar for containment suits and flak jackets, automotive paints, non-stick coatings, agricultural pesticides and hybrid seeds, photovoltaic films for solar power, aerospace textiles, synthetic construction materials and pharmaceuticals – DuPont covers is all and much more.

Feeding 7 billion people is no small task, but Monsanto (NYSE:MON) is up to the job. Developing hybrid seeds to maximize yields and expanding the range of limited farmland is their primary focus. But this spring when you spread the Weed ‘n Feed on your lawn and fertilize your tomato plants, Monsanto is there too.

Uncertain about gold prices? Freeport-McMoRan (NYSE:FCX) isn’t just a gold miner, but one of the largest copper producers in the world. Newmont Mining (NYSE:NEM) also mines both copper and gold and it the favorite of the industry for mutual funds. Not only do we have the need for copper in all the apartment buildings needed to be built for a new generation of renters, but there are thousands of properties begun in the early 2000’s that need to be completed. A new wave of “Quantitative Easing” (QE3) by the Fed will bring another rally to gold.

Dow Chemical Company (NYSE:DOW) overlaps much of DuPont and Monsanto but also includes numerous home and personal products for hygiene and infection control, insulation, packaging, sealants and adhesives. It would be nearly impossible to find a household in America that didn’t have a Dow Chemical product in it.

It is clear to see from the Money Flow Index at the top of the chart that the demand for Basic Materials is so high, that investors are willing to pay a premium price for this ETF. The Stochastic indicator hit the maximum range of 100 and parked there nearly a month. The +/- Directional Index shows the bulls took the lead in 2012.

The price of XLB is currently at the upper trend line resistance from a huge move up on Wednesday. The ADX is at 29.47 and rising rapidly. A level of 40 on the ADX usually signals a price directional movement. We have a negative divergence on the MACD of the rising signal line and declining histogram. These three factors indicate a likelihood of a pullback – which is just what we want to enter this position.

There is good support under the current price. Should the overall market remain relatively strong and outlook is positive, a minimal pullback to the 200 day moving average at $35.76 would keep XLB in bull market territory. Four tests of the lower channel support have been successful and a projection of that price level would be around $35.00.

The 2008 price of XLB peaked around $44 after a strong move before the crash. Mid July 2010 to mid-July 2011, XLB marched from $27 to $41 hardly missing a step. A pullback from current resistance, could give XLB the thrust to push through to the 2011 highs of $41 and there’s a good possibility to reach new highs in 2012.

If leveraging is your investment style, options are available on XLB with reasonable liquidity or ProShares Ultra Basic Materials (NYSEArca:UYM) offers nearly 2x leveraging.

XLB is a highly diversified ETF holding the best of breed for cyclical growth in Basic Materials.

Disclosure: I currently have no position in XLB.

Written By David Gillie For The ETF Digest

ETF Digest writes a subscription newsletter focused on technical  analysis of exchange-traded funds.  ETF Digest was founded in 2001 and  was among the very first to see the  need for a publication that  provided individual investors with  information and advice on ETF  investing.  Even if you’re not a fan of  chart analysis, ETF Digest  provides insight and commentary into which  global markets are “working”  and why.

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