Basic Materials Can Lead to the Upside

We have recently been highlighting what amounts to a lot of bottom-fishing candidates. This isn't our preference when trying to find long ideas, but then again, we have to take what we can and find whatever opportunities there are. After a 40% decline in the major indices, it's tough to find anything that has a positive technical configuration beyond a short-term consolidation or base that could produce a short-term rally.

We have been focusing our fishing efforts in the hardest-hit and last-hit sectors of the market during the decline -- commodity and basic materials stocks. There is a reason for this -- these groups typically snap back first and with the most vigor as investors look to find bargains in the previous leadership areas. These sectors also have hard assets, which isn't a bad thing when financial assets are eroding quickly.

Also working in support of firmer commodity prices and in turn firmer basic material prices is a weakening dollar. The dollar had reached long-term resistance over the past few weeks and has been falling back. A falling U.S. dollar is supportive to basic material prices and crude oil prices. The actions by the Fed will only further these trends as the impact of lower interest rates and assumption of more assets on their balance sheet lowers the demand for U.S. dollars.

As the fundamental factors begin to shift in favor of a rise in basic material prices and the market attempts to simply work off some of the deep selling pressure, we are seeing improving price action from the SPDR Metals & Mining (XME - commentary - Cramer's Take) ETF. The XME has broad exposure to various metal producers and mining companies; this gives you exposure to not only companies with hard assets in the ground but those that process such metals as well. This is only a subtle improvement, but it does bear watching for a potential rally. In fact, the rally in basic materials may be a situation where they enter a rally phase while the rest of the market does whatever it does. In other words, it may be a situation where the basic material group becomes independent of the overall market moves.

SPDR Metals & Mining (XME)

What is most intriguing is the consolidation that has formed, indicating a tradable low is in place. We can see at the November lows there was no downside follow-through and a quick recovery. We would be buyers of the XME at current levels and look for a move up to the $40 level.

The next key resistance level is at $30; a close above that level should provide some increased momentum to the upside. This suggests there are few sellers left in this ETF. Use a move below $25 as a stop on long positions.

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Know what you own: Hughes and Maragioglio mention the XME. Other ETFs that track specific industries include the Financial SPDR (XLF - commentary - Cramer's Take), the Energy SPDR (XLE - commentary - Cramer's Take), the Consumer Staples SPDR (XLP - commentary - Cramer's Take), the Technology SPDR (XLK - commentary - Cramer's Take), the Health Care SPDR (XLV - commentary - Cramer's Take) and the Utilities SPDR (XLU - commentary - Cramer's Take).

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At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned. Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.