Mulling a Materials ETF Amid Value, Weakness in the Sector | ETF Trends

The Materials Select Sector SPDR Fund (XLB), the largest ETF dedicated to materials stocks, and rival materials ETFs are being pinched this year, but there’s a value case for the sector.

XLB “seeks to provide precise exposure to companies in the chemical, construction material, containers and packaging, metals and mining, and paper and forest products industries,” according to State Street.

Due to their close ties with the commodities market, materials stocks and ETFs are susceptible to cyclical demand and volatility in raw material and energy prices. While the sector’s sensitivity to business cycles can expose investors to greater risks, the area may also offer attractive returns during periods of strong growth.

“However, a closer look reveals that most of the discount is concentrated in just a few industries. Few opportunities exist among those with heavy U.S. exposure as the economy continues its extended expansion. Rather, we see discounted valuations in sectors facing idiosyncratic challenges,” said Morningstar in a recent note. “Market prices imply that these issues are here to stay, but we think the headwinds are temporary and ultimately surmountable.”

Examining XLB

The basic materials sector is a category of equities that represent companies involved in the discovery, development, and processing of raw materials. The sector includes companies engaged in mining and metal refining, chemical products, and forestry products.

Companies in this sector supply most of the materials used in construction and development. As a result, they are sensitive to changes in the business cycle and tend to thrive when the economy is strong.

“We are bullish in our long-term outlook for lithium. Although lithium carbonate prices currently sit below $10,000 per metric ton, we are well above consensus implied prices of $7,500 due to our above-consensus electric vehicle adoption forecast of 20% in 2030 versus consensus of 15%,” according to Morningstar.

Related: Rare Earths ETF Contends With Increased Shipments

A resurgence in another alternative energy source could be a surprise boost for smaller materials names this year.

“At one point in 2019, uranium spot prices had fallen 17% to roughly $24 per pound, weighed by still-weak purchase activity. The market has begun to show life, with prices recovering to $26 per pound and, more critically, enrichment demand increasing. The market-implied price suggests little recovery left, but we expect production discipline and rising demand will lead prices to recover to $65 per pound by 2022,” notes Morningstar.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.