Materials sector exchange traded funds have their moment in the limelight, capitalizing off a stronger U.S. dollar, despite falling commodities prices.
Year-to-date, the Materials Select Sector SPDR (NYSEArca: XLB) rose 5.9%, Vanguard Materials ETF (NYSEArca: VAW) gained 5.1%, iShares U.S. Basic Materials ETF (NYSEArca: IYM) added 4.4% and iShares S&P Global Materials (NYSEArca: MXI) advanced 6.3%. In contrast, the SPDR S&P 500 ETF (NYSEArca: SPY) was up 2.1% so far this year.
The stronger greenback is bolstering returns from foreign mining operations since the companies receive dollars for metal ore extracted from the ground while costs are denominated in local currencies, the Wall Street Journal reports.
Additionally, the stronger USD is also supporting mining projects where some producers are even expanding production as currency moves diminish costs, even as commodity prices have been tumbling. Consequently, with supply continuing to rise, some observers are expecting metal prices to fall and remain pressured.
For instance, despite reporting a loss for 2014, Anglo American PLC pointed out that foreign operations in countries with weaker currencies helped the company generate $1.3 billion in profits, which helped soften the $2.4 billion hit the producer took in falling commodities prices. Anglo American makes up 1.4% of MXI.
Additionally, Rio Tinto stated that its profits rose on the weaker Canadian and Australian dollars. MXI includes a 3.3% tilt toward Rio Tinto.
However, some observers warn that the current strength in the mining sector could be fleeting, pointing out that mining expansions would only feed the global commodities glut, demand is slowing in China and producers borrowed heavily in U.S.-denominated debt.
“The stronger dollar has been cushioning some of the blow of weaker commodity prices…but not all,” Daniel Rohr, director of materials research with research firm Morningstar Inc, said in the WSJ article. “Miners need to grow production, deliver cash to shareholders and maintain a strong balance sheet, and in a weaker price environment you cannot do all three.”
Moreover, materials are strengthening, along with other cyclical sectors, are also strengthening in a rising rate environment as investors turn away from safer assets and shift into riskier areas of the market. [Late Cycle Rally has Materials ETFs Spring to Life]
Materials Select Sector SPDR
For more information on the materials sector, visit our materials category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own shares of SPY.