Commodities Cratered by Snarling Bears

Buy put spreads on a bounce in FCX

Commodities Cratered by Snarling Bears

It appears the bears have finally awakened from their long winter’s slumber. After being virtually absent from the market this year, the bears finally delivered a bona fide distribution day worth talking about. Wednesday’s trading session was a relentless slide halted only by the closing bell. By day’s end, the S&P 500 was down 1.25% while the small-cap Russell 2000 was off by 2%.

But equities weren’t the only asset class to feel the bears’ wrath. Selling in the already beleaguered SPDR Gold (NYSE:GLD) intensified, taking the world’s largest gold ETF down another 2.5%. Not to be outdone, silver — considered by many the higher-beta cousin of gold — slumped more than 3% on the day.

The commodity collapse was exacerbated by the persistent strength in the U.S. dollar. Historically, commodities from gold and silver to oil and copper exhibit a negative correlation with the dollar. Picture the buck and commodities on opposite ends of a teeter-totter — when one rises, the other falls. The Powershares DB U.S. Dollar Index (NYSE:UUP) closed the day up 0.73% with a powerful bullish candle.

XLB chart 300x223 Commodities Cratered by Snarling Bears
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Not surprisingly, the weakness in the commodity space weighed on the SPDR Basic Materials (NYSE:XLB). Yesterday’s 2.81% free fall drove the already weakened sector below a few key support levels, placing its current intermediate uptrend into question. What’s more, the XLB is the only sector currently residing below its 50-day moving average. The chart at right also shows that the comparative relative strength (CRS) has entered a veritable free fall.

The worst performing component of XLB was Freeport-McMoran Copper & Gold (NYSE:FCX), which fell just shy of 6%. I suspect the selling in FCX was made even worse by copper’s participation in the commodities bloodbath. Both securities exhibit a positive correlation to FCX.

FCX chart 300x184 Commodities Cratered by Snarling Bears
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In the short run, FCX is ridiculously oversold — so it’s unwise to enter bearish plays at current prices. But any kind of bounce in the coming days will set up a more appealing entry point for traders who think the downtrend in materials in general — and FCX in particular — is likely to continue.

On a rebound toward $33 or $34, traders might consider positioning themselves for an eventual retest of the December support level around $30.50 by purchasing the FCX April 34-31 bear put spread: Buy the April 34 put and sell the April 31 put. The max risk is limited to the initial debit spent — $1.64 at current prices, but the spread should become cheaper if the underlying bounces — and will be incurred if FCX is above $34 at April expiration. The max reward is limited to the distance between strikes minus the initial debit and will be captured if FCX is below $31 at April expiration.

At the time of this writing Tyler Craig had no positions in any of the aforementioned securities.

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