XME: My Favorite Way to Play Commodities

 |  About: SPDR S&P Metals and Mining ETF (XME), Includes: SPY
by: Patrick Young

The SPDR Metals and Mining ETF is my favorite way to play commodities. It invests in companies that produce all the raw materials that the industrial and tech manufacturers require - i.e. "The Hard Stuff".

XME actually offers a great deal of diversity, investing in companies that range from steel producers, base and precious metal miners, coal miners, specialty metallurgists, and industrial manufacturers of finished metal products for use in construction, etc.

XME vs S&P over the last 5 years (from Google Finance) Click to enlarge

click to enlarge

Above is a graph of the S&P and XME since 2006. The important thing to notice is that if I bought $10,000 of equity in the S&P or XME in 2006, and sold in 2009, I would have lost 50% of my investment either way, but if I bought XME in 2006 and sold in 2008, I could have beat the S&P by an order of magnitude.

Of course, I could have lost nearly all my money by buying commodities in 2008 and selling in 2009, but there were ample red flags not to do. Which ones? Many forget that before the general crash in the fall of 2008, there was a major oil price shock. History, this year at least, does NOT appear to be repeating itself.

This is evident from looking at the previous peak and our current position in the same time-frame.

The graph below shows oil, XME, and SPY in the 2 years before the crash:

Click to enlarge

We can see that oil prices spiked way above the market before the crash. Because coal tracks oil, XME spiked as well.

The graph below shows the same group of equities in the last 2 years (since the bottom):
Click to enlarge

In the current environment, the outperformance of the commodity ETF is not necessarily because of an oil price shock. The market has performed well, so the commodity ETF has performed exceptionally well.

So, if the downside risk on commodity stocks is no worse than for the general market in a crash, and the upside so much larger in boom times, why not risk it all on the equities that boom way above the rest of the market in good times - the commodity producers?

There are other reasons to believe in commodities: I can say with a very high degree of confidence that if 6 billion people on this planet want to live like I do, the world will need a lot more steel, copper, and most of all, coal.

For these reasons, XME is my SPY.

Disclosure: I am long XME.