Commodities Cratered by Snarling Bears

by Tyler Craig | February 21, 2013 8:39 am

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[1]) 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[2]) 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[3]). 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[4]), 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
Click to Enlarge
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.

Endnotes:
  1. GLD: http://markets.financialcontent.com/investplace./quote?Symbol=GLd
  2. UUP: http://markets.financialcontent.com/investplace./quote?Symbol=UUP
  3. XLB: http://markets.financialcontent.com/investplace./quote?Symbol=XLb
  4. FCX: http://markets.financialcontent.com/investplace./quote?Symbol=FCX

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