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Trading the Undervalued Basic Materials Sector

NEW YORK ( TheStreet) -- Investors looking to capture gains from a global economic recovery should look to the basic materials sector for stocks engaged in the production of chemicals, fertilizers, paper, building materials, steel, gold, copper, iron and other specialty items that make up the guts of the global economy.

One way to participate in this market is through the Materials Select Sector SPDR Fund (XLB), which includes stocks of 30 companies that operate in these industries.

It may be time for investors to give the Federal Reserve the benefit of the doubt. Isn't it time that Federal Reserve policy finally gets the U.S. economy and then the global economy back on track?

We have had a zero to 0.25% federal funds rate since mid-December 2008. This was followed by the expansion of the Fed's balance sheet to around $2.8 trillion on June 2011 when the second round of quantitative easing, or QE2, ended. Policy action then shifted to "Operation Twist" last September.

Today, expectations include the call for another $500 billion addition to the balance sheet via QE3, which could be announced after this week's Federal Open Market Committee meeting ends tomorrow afternoon. During a QE3, the Fed's balance sheet would bulge to $3.3 trillion from below $1 trillion prior to the "Great Credit Crunch," which began at the end of 2007.

The prospect of a return to global growth should help the basic materials sector. Investors can capture this trend using my "buy and trade" strategy on the Materials SPDR. The weekly chart shows XLB plummeted 61.7% from its May 2008 high of $46.54 to its March 2009 low of $17.83. The rally from that March low into the April 2011 high at $41.28 was a gain of 131.5% on hopes of an economic recovery.

Source: Thomson Reuters

The daily chart shows that since that April 6, 2011 high at $41.28 the XLB has moved sideways to down, as shown by lower highs right through QE2 and Operation Twist. This is a warning that Federal Reserve policy is not getting the desired results of an improving economy.

From the weekly chart, a close this week above the five-week modified moving average at $34.96 keeps the weekly chart profile positive. From the daily chart, a trend above the 200-day simple moving average at $35.20 increases the odds that this sideways to down pattern can be broken.
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XLB $41.97 4.00%
MON $87.73 2.30%
NEM $17.69 12.00%
SHW $240.39 3.70%
DD $49.85 3.10%


Chart of I:DJI
DOW 16,636.79 +164.42 1.00%
S&P 500 1,951.36 +27.54 1.43%
NASDAQ 4,707.7750 +80.6910 1.74%

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