This article originally appeared earlier today on ETF Profits.
At the beginning of March, we highlighted the metals and mining sector as a group showing weak relative strength vs. the broader market rally and thought it could remain vulnerable to further downside. We see a confirmation of our original thesis as the sector is breaking down and the bears are gaining traction. The door is open for more bearish pressure on this group and for the currently weak technical price structures to expand. Continue to play the short side of the metals and mining group0 in the weeks ahead, as the sector could act as the downside leader if the broader market moves into a corrective phase or the idea of slowing emerging market growth starts to take hold.
Metal and mining names started the month in a bearish position, and traders are now latching on to the thesis of slowing Chinese growth, which should exacerbate weakness in the commodity-related sectors of the market. The index has broken to the downside of a bearish triangle consolidation pattern, which formed following a downside break from the cyclical uptrend channel in August 2011, and confirmed that the bears have the upper hand. These price structures weigh heavily to the downside, and the path of least resistance in the daily and weekly charts remains on the downside, as well.
This price action is confirmed by the weak breadth line. Liquidity continues to flow away from the group, and strength is eroding internally. The weakness stands out against the unusual broad-based strength and bullish undercurrent in the general market environment. The rising dollar has kept the commodity index in a corrective phase this year, with the exception of crude oil, and the weakness in base metal prices is being exasperated by the idea that China's economy could be in for a 'hard landing'. Traders seem to have no reason to take a chance on this group at the moment and 'catch a falling knife,' especially considering that the market currently offers many other bullish opportunities.
Continue to approach the metals and mining names from the short side and look to capitalize on a further breakdown in the group. If the bearish theme on China gains traction with traders, we could see downside leadership develop in this sector. Money is flowing away from the group, and the bulls are showing a lack of interest in intervening on the upside.
The SPDR S&P Metals & Mining ETF (XME) (XTF rated 6.7) is an equal-weighted fund, which should accurately capture the internal weakness of the sector. We would short XME at $50 as it breaks to the downside of the bearish triangle consolidation pattern. The breakdown confirms that the bears have traction and prices are headed lower. We would target the prior bullish turn in the group at the 2009 lows as support and look for $31 to take downside profits in a best case scenario. A turn to the upside and a break above $55 would nullify the bearish pattern and show the bulls trying to regain control. Use the $55 level as a stop loss on the trade.
Not many opportunities exist in this market to profit on the short side. But the metals and mining sector is in a technically weak situation, and we believe traders can take advantage of the bearish action.