The Prudent Approach to Materials ETFs

In somewhat quiet fashion, the Materials Select Sector SPDR (NYSEArca: XLB) is trading not just near 52-week highs, but at its highest levels since 2008.

Although XLB is off 0.04% this year, that performance is still good enough to rank the ETF in the top half of the nine sector SPDR ETFs on a year-to-date basis. However, materials ETFs are coming off a disappointing January, a month that is usually kind to the sector. [Two Sector ETFs for January]

The sector’s recent lethargy could be a sign XLB and rival ETFs should be approached with caution in the near-term. The charts confirm as much.

“We’ve see what some of these other sectors have done upon their breakouts (healthcare is a great example), but Material prices have yet to prove they can absorb all of this overhead supply. I think it’s worth waiting for. Shorts, on the other hand, can use these levels as a stop. The risk/reward is definitely skewed in favor of the bears up here in the short-term,” notes J.C. Parets of Eagle Bay Capital.

XLB’s relative strength against the S&P 500 has been slumping since late 2010 and although that situation has recently shown faint signs of improving, XLB is still a long way from being in a stronger spot than the benchmark U.S. index.

“We can see that XLB/SPY has broken above this downtrend line from 2011, yet still below all of this broken support. If we start to see a breakout back above those lows, then we can make a solid argument for a relative overweight in the basic materials space,” notes Parets.