Metals, Mining, And Energy Stocks Are Unquestionably The New Market Leaders

| About: VanEck Vectors (GDX)


With everyone looking for a continuation of the year-long correction/bear market, a rotation is occurring.

Inflation-oriented assets, including economically sensitive material and energy shares, are thriving.

Late-cycle plays historically lead aging bull markets.

The market has a way of humiliating as many people as it can.
Steve Sosnick

Over the past five years, a deflationary tidal wave has swamped the world financial markets, driving sovereign bond yields to record lows, and sucking the life out of inflationary assets. Despite the clear deflationary pull, the largest U.S. stock prices stubbornly held near their highs, becoming a safe-haven for global asset flows.

Like a phoenix reborn, however, inflationary assets have risen from the ashes after an ominous start to 2016. Out-of-favor countries, like Brazil, as measured by the iShares MSCI Brazil Capped ETF (NYSEARCA:EWZ), are now powering higher despite an unrelenting stream of negative political news.

Mining, material, and energy stocks, which are traditionally late economic cycle plays, have taken over market leadership, as China eyes a cyclical upturn, ending a unique five-year era in modern financial market history.


Late cycle economic plays, including inflationary sensitive assets, are signaling a revival in global growth prospects.

Gold Leads The Inflationary Rally

Commodities and commodity stocks have been struggling since April of 2011. Gold, and crude oil, were the last holdouts against the deflationary tsunami of slowing global growth. With nearly everyone looking for gold to break the $1000 per ounce level entering 2016, the yellow metal has unexpectedly reversed higher. The chart of the SPDR Gold Shares ETF (NYSEARCA:GLD) shows this reversal.

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With gold closing above the $1250 per ounce level yesterday, gold stocks, as measured by the Market Vectors Gold Miners ETF (NYSEARCA:GDX) have surged 67% higher in 2016.

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The top-ten holdings in the GDX are Barrick Gold (NYSE:ABX), Newmont Mining (NYSE:NEM), Goldcorp (NYSE:GG), Franco-Nevada (NYSE:FNV), Newcrest Mining (OTCPK:NCMGY), Agnico Eagle Mines (NYSE:AEM), Rangold Resources (NASDAQ:GOLD), Anglogold Ashanti (NYSE:AU), Silver Wheaton (NYSE:SLW), and Kinross Gold (NYSE:KGC).

Barrick Gold Corporation is the world's largest gold company, and it is up 122% year-to-date in 2016.

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To recap, gold, which was one of the last commodities to fall from grace, is leading a commodity rebound this year. Gold stocks, which historically lead the price of gold, are surging higher at a far faster pace than the metal itself. Finally, gold, which historically does well in times of inflation and deflation, appears to be confirming a transition to an inflationary investment environment.

Steel Stocks Surge

Gold has led the upward move in material stocks in 2016, but the strongest reversal has come from the beleaguered global steel sector. After struggling to start the year, the SPDR S&P Metals and Mining ETF (NYSEARCA:XME), which includes Cliffs Natural Resources (NYSE:CLF), Schnitzer Steel Industries (NASDAQ:SCHN), Coer Mining (NYSE:CDE), U.S. Steel (NYSE:X), Stillwater Mining (NYSE:SWC), Freeport-McMoRan (NYSE:FCX), Steel Dynamics (NASDAQ:STLD), Carpenter Technology (NYSE:CRS), Worthington Industries (NYSE:WOR), and Kaiser Aluminum (NASDAQ:KALU) in its top-ten holdings, has advanced 47% YTD.

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U.S. Steel, which was one of the first companies profiled in a series I titled Too Cheap To Ignore, has paralleled Barrick Gold, and advanced 122% year-to-date.

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On a YTD basis, AK Steel (NYSE:AKS) is up 100%, Cliffs Natural Resources is up 152%, and Teck Resources (NYSE:TCK), the world's second largest exporter of metallurgical coal, a key steel making ingredient alongside iron ore, is up 125%.

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As the above five-year chart of Teck shows, there is more room to run on the upside, if the reversal, and rally in inflationary assets continues.

Energy Stocks Rebound - Driving High Yield

As the ongoing bear market in a majority of U.S. stocks gathered steam in January and February of 2016, a key area of concern for market participants was the high yield bond arena, as many high yield bond portfolios and benchmarks had significant energy exposure. The breakdown of crude oil in the first months of 2016, when oil dove below $30 per barrel, amplified the worries. However, crude oil has rallied strongly off its lows, closing above $43 per barrel yesterday.

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The rally in crude oil, and natural gas, has driven a rebound in energy equities, with the larger capitalization Energy Select Sector SPDR ETF (NYSEARCA:XLE) now up roughly 7% for the year.

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The XLE's top-ten holdings are industry heavyweights, and include Exxon Mobil (NYSE:XOM), Chevron Corporation (NYSE:CVX), Schlumberger (NYSE:SLB), Pioneer Natural Resources (NYSE:PXD), EOG Resources (NYSE:EOG), Occidental Petroleum (NYSE:OXY), Valero Energy (NYSE:VLO), Phillips 66 (NYSE:PSX), ConocoPhilips (NYSE:COP), and Halliburton (NYSE:HAL).

Chesapeake Energy (NYSE:CHK), which is the second largest producer of natural gas in the United States, has staged an even more dramatic rebound, with shares now up 34% in 2016, after being down over 60% earlier in the year.

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The rally in Chesapeake exemplifies the turnaround in the more out-of-favor energy stocks, and the rebound in these beaten down companies has driven a rebound in high yield shares, as shown by the charts of the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) and the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK).

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HYG and JNK have both closed above their 200-day moving averages for the first time since the middle of 2015, a positive sign for the broader equity markets.

Late Stage Cyclicals Lead An Aging Bull

With all the positive news, the S&P 500 Index, as measured by the SPDR S&P 500 ETF (NYSEARCA:SPY), has rallied to recapture a modest 1.5% gain in 2016, after being down materially in January and February.

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As we detailed above, mining and material stocks, as measured by the XME are up 47% YTD. That sounds impressive, until you look at their relative performance over the past five years.

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From the above chart, SPY is up 74% over the last five-years, while XME is still down 67%, so there could be a lot more meat left in the mean reversion trade. Thus, the rotation into late-cycle inflationary and economically sensitive assets could just be getting started.

Building on this, emerging markets, as measured by the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) are now up 7% YTD, yet they still trail SPY by a large margin over the past five years.

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The performance gap between emerging markets and the S&P 500 Index, as measured by the SPY, is not as massive as the gap between the XME and the SPY, but it still shows a large divergence. Thus, even though emerging markets like Brazil, have appeared to rally more than their fundamentals justify, the reversal could be just getting started.

Martin Pring, who has his own research website, is one of my favorite research analysts. His business cycle research is terrific, in my opinion. The following graph shows the business cycle and theoretical asset class performance according to each stage of Pring's cycle.

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From my interpretation, on a global basis, it appears we are exiting stage 3 and entering stage 4, which would mean that investors should strongly consider increasing their allocations to inflation sensitive assets and reducing their bond exposure. I have preferred overweighting commodity stocks, but another opportunity might be in shorting bonds, and I have dabbled in shorting the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT), as I believe the thirty plus year bond bull market is coming to an end.

Time For A Contrarian Approach

2016 has been a terrific year for contrarian investors thus far. While the year started off horrendously for many out-of-favor assets, the month of January appeared to bring capitulation. Since then, having exposure to downtrodden assets has been very positive for most portfolios.

After being beaten and bruised up from 2013-2015, and learning some of my hardest business, investment, and life lessons, I launched a premium research service on Seeking Alpha, titled "The Contrarian". Within this research service, I have various portfolios that are used to express the research views and to articulate portfolio strategy.

The most popular portfolio is the "Bet The Farm" Portfolio, and I have described the rationale behind this concentrated portfolio in a public article on Seeking Alpha. On a weekly basis, every Monday, and when new trades are initiated, I post an update, and subscribers have been able to follow along since the portfolio's inception. The following update is from the close of the markets, on Tuesday, April 12 th, and it shows the power of a concentrated options portfolio when you are on the right side of the trade.

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For the first two days of this week, the "Bet The Farm" Portfolio is up 41%, and since its December 7 th, 2015 inception, the "Bet The Farm" Portfolio is up 143%. The gains have been driven by open call option positions in Teck Resources, Freeport-McMoRan, Unit Corporation (NYSE:UNT), Consol Energy (NYSE:CNX), Chesapeake Energy, Southwestern Energy (NYSE:SWN), Cliffs Natural Resources, U.S. Steel, Cloud Peak Energy (NYSE:CLD), offset by losses in open call positions in SunEdison (SUNE) and Peabody Energy (BTU).

Additionally, there are gains in two closed positions in U.S. Steel call options, and iShares NASDAQ Biotechnology ETF (NASDAQ:IBB) put options.

The most recent trade recommendation sent out to subscribers was a purchase of CLF call options on 4/4/2016, and this position is already up 69%, though it is not closed yet, so anything could happen.

As I write this article on Wednesday morning, Peabody Energy has officially declared Chapter 11 bankruptcy, and readers will notice that I initiated several positions in BTU call options in the "Bet The Farm" Portfolio. These did not work out, and are complete losses at this juncture.

While I believe it is a sad day in America, when the world's largest publicly traded coal miner declares bankruptcy, amidst an ongoing recovery in metallurgical coal, I have learned the hard way that out-of-favor companies sometimes do not work out, and complete losses have to be factored into portfolio strategy when investing in deep value, out-of-favor equities.

Conclusion - A Transition Has Taken Place

The broader stock market continues to churn near its highs, but under the surface, a clear transition in market leadership has taken place. Winners from 2015, like Amazon (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX) remain down 10%, and 5% respectively, while laggards in 2015, and over the last five years, including metals, mining, and energy stocks are now reversing higher and leading the stock market.

The U.S. Dollar, which exploded higher in 2014, is now giving back a portion of its gains, adding a tailwind to the rally in inflationary assets, as almost all commodities are priced in U.S. Dollars.

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Historically, leadership by inflation sensitive and economical sensitive assets marks the last phase of an aging bull market. Investors should take note of this historical significance, and prepare their portfolios accordingly, by considering and implementing alternative investment strategies.

Disclosure: I am/we are long ABX, BTU, CHK, CLD, CNX, CLF, FCX, SWN, SUNE, TCK, UNT, X, AND SHORT AMZN AND SPY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Every investor's situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.