This column was originally published on RealMoney on June 18 at 12 p.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
The major averages jumped back to their rally highs last week in a strong recovery that wiped out the latest wave of committed short-sellers. This marks the umpteenth time in 2007 we've watched stocks bounce strongly off shallow pullback lows. But this latest uptick shows decidedly mixed messages in the leadership driving this year's intense rally.
In particular, industrial metals show strong variation in recent performance, pointing to a loss of momentum that may precede a sharp correction in the group. This adds an unexpected twist to the market landscape because capital coming out of these sectors could find its way into less popular stocks and broaden the narrowly focused uptrend.
It's also possible that weakening metals will short-circuit the latest recovery and trigger another downdraft in the major indices. This makes sense, with the added weight of spiking crude oil prices and rising bond yields. If so, we could be looking at the next phase in a broad topping pattern that finally yields the elusive midyear correction.
price action raises a cautionary flag for the entire sector. The blue chip had been grinding higher in a furious uptrend when it spiked sharply on June 8 after the latest wave of takeover rumors. But it turned tail and gapped down more than 5 points the following session, when the alleged suitor denied interest in buying the company.
The stock couldn't recover much lost ground last week, despite strong support from the major averages. This suggests the vertical rally up to 127 was a climactic event that exhausted buying pressure. If so, price should continue on a downward path in coming months and drop well below round number 100 before finding substantial support.
Other steel stocks tagged 2007 highs at the start of June and then pulled back ahead of the U.S. Steel slingshot. This secondary group shows mixed performance this month, with
looking vulnerable, while
Companhia Vale Do Rio Doce
could easily break out to new highs.
Copper is also painting a mixed picture as we head into the summer months. Sector leader
is firing on all cylinders and trading near an all-time high in the mid-80s, following a vertical run that began at 72.50. But rival
Southern Copper Corp.
( PCU) shows early signs of declining momentum.
That stock rallied into a test of its June 4 high late last week after pulling back almost 9 points. Notably, on-balance volume is raising a cautionary flag at this time because weakening accumulation has marked each high printed in the last six weeks. This is the type of pattern often seen at significant tops.
Admittedly, the instrument could easily take out the old high and rally into resistance at round number 100. But the OBV divergence will need more than 5 points of upside progress to resolve the bearish signal. So, I recommend that interested parties watch for further signs of buyers' exhaustion in this industrial-metals leader.
Aluminum is sitting in the metal group's sweet spot right now, with
pushing above three-year resistance at 39 during last week's recovery. But the
component faces an additional cluster of overhead supply as it presses into its 2001 high at 45.71. This should mark a substantial barrier that takes a number of months to overcome.
This scenario matches the adverse risk-to-reward profile noted in the Southern Copper chart. Simply stated, both instruments look like great swing trades, but poor investment vehicles at this juncture. So those with a longer time horizon should keep their powder dry and look for sectors benefiting from capital coming out of these overextended stocks.
Traders hunting for short-term metals plays should avoid the short side for now. A topping market isn't the same animal as one that's getting sold aggressively. Instead, focus on bounce plays that have substantial upside into resistance at recent highs. Here is an interesting setup that fits this profile perfectly.
rallied from 70 to 92 in the latest wave of its long-term rally. That vertical spike stalled out in early June, with price retracing sharply in the last two weeks. Note how the stock closed right near the 80 strike during last week's expiration. This sets up the perfect conditions for a strong recovery back to the high.
Look for a final pullback that tries to fill last Friday's gap. That decline might carry as far as 78.50. That downtick should yield to a stronger bounce that presses toward the old high. Keep stops tight during the recovery because sellers could re-enter the market at any time. Don't hesitate to take profits aggressively as price approaches resistance.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
Alan Farley is a professional trader and author of
The Master Swing Trader
. Farley also runs a Web site called HardRightEdge.com, an online resource for trading education, technical analysis and short-term investment strategies. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Farley appreciates your feedback;
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