More Pain Ahead For Basic Materials ETFs In 2016?

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Includes: IYM, PICK, XLB, XME
by: Zacks Funds

It's been years since basic materials ETFs last saw their days of glory. As for the last few years, the space has been an area of concern, thanks to a surging greenback, massive crash in oil prices and hard landing fears in China. Moreover, supply glut has been a long-lasting issue for this space.

Things were fragile for long in China given the protracted slowdown in the domestic manufacturing sector, credit crunch concerns and a property market slowdown. As a result, the Chinese economy has been undergoing a tumultuous phase for the last few months. To shore up the ailing economy and the turbulent market, the Chinese government took several measures; but nothing could really heal the pain.

Since the Chinese economy accounts for about half of the global consumption of industrial commodities and is the second biggest purchaser of oil, a further slowdown in the Chinese economy would mean weaker demand for commodities. In any case, most developed economies are presently in a state of slowdown and thus require lesser commodities for weak demand.

Also, the strength in the greenback owing to Fed policy tightening marred the broader commodity prices as most of these materials are priced in the U.S. dollar. Also, a hike in interest rates tends to boost investors' interest in income-generating assets and thus hurts the investment demand for non-yielding commodities. So, all in all, fears of softening demand amid abundant supplies have led to a broad-based meltdown in commodities prices.

Commodities at Multi-Year Lows

Copper prices have already plunged to a new six-year low on Chinese economic issues. Events in China are major contributors as the country is the world's biggest consumer of this industrial metal, making up roughly 40% of global copper demand. Thus, a prolonged manufacturing slowdown in the world's second largest economy cast a dark cloud over the red metal.

Iron ore fell to a five-and-a-half year low in December 2015 and analysts predict that the rout can deepen further as "Chinese steel mills rebuild the inventory." Nickel prices plummeted to a 12-year low on low demand from "the stainless steel sector, the dominant source of demand for nickel."

Most agricultural commodities are also in the red. The oil price rout is getting more and more acute lately with Brent crude having slipped to a 12-year low and WTI crude falling to a seven-year low. Analysts expect the pressure to remain in place.

ETFs to Lose More in 2016

iShares U.S. Basic Materials ETF (NYSEARCA:IYM) - Down 20% in the last one year (as of January 12, 2016) and about 9.6% year to date. The fund is the most exposed to chemicals though steel, gold and aluminum take about 10% of the fund.

SPDR Materials Select Sector Fund (NYSEARCA:XLB) - Down 16.4% in the last one year (as of January 12, 2016) and about 9.2% year to date. The fund puts 73.8% off its assets in the chemical sector followed by 9.5% of assets in the metals & mining sector, and 8.7% in containers and packaging sector. The fund is heavy on Du Pont (NYSE:DD) (11.4%) and Dow Chemical (NYSE:DOW) (11.2%).

SPDR S&P Metals & Mining ETF (NYSEARCA:XME) - Down 53.9% in the last one year (as of January 12, 2016) and about 15% year to date. Steel occupies almost half of the portfolio followed by 10% in aluminum, diversified metals and gold each.

iShares MSCI Global Metals & Mining Producers ETF (NYSEARCA:PICK) - Down 50.4% in the last one year (as of January 12, 2016) and about 15.8% year to date. Materials hold about the entire fund though consumer services and consumer durables take a slight portion of the ETF. The fund's main focus is on companies like BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO) and Glencore (OTCPK:GLNCY).

Bottom Line

With the operating backdrop in 2016 expected to be no different than 2015, the basic materials sector will replay the same pattern that we saw in the recent past. At Zacks, we have most of the materials ETFs as Sell-rated at the time of writing.

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