3 ETFs to Play the China-Driven Basic Materials Sector Breakout

Basic materials stocks bore the full brunt of a "risk off" market environment in the fourth quarter of 2018 as investors dumped names caught in the crossfire of a tit-for-tat tariffs trade war between the United States and China and those with exposure to slumping oil prices. Over the period, the Dow Jones U.S. Basic Materials Index (^DJUSBMT) fell nearly 15%, plunging the sector into correction territory.

As news of planned January trade talks between Washington and Beijing filtered through in late December, the dark clouds over the basic materials sector started to dissipate. Basic materials stocks were given another boost Friday when reports emerged that China had offered a six-year increase in U.S. imports during recent trade talks. The deal supposedly intends to reduce the U.S. trade deficit with China from $323 billion in 2018 to zero by 2024.

"If we don't get that issue resolved, the market is going to hit upside headwinds no matter what happens. If we get that issue out of the way, which will boost business and consumer confidence, there is still plenty of room for the market to do really well," said Randy Frederick, vice president of trading and derivatives at Charles Schwab & Co. Inc. (SCHW), per CNBC.

From a technical standpoint, leading basic materials exchange-traded funds (ETFs) have broken above key resistance, which provides swing traders with a short-term buying opportunity. Let's take a closer look at three specific funds.

Materials Select Sector SPDR ETF (XLB)

The Materials Select Sector SPDR ETF (XLB) aims to provide investment results that correspond to the performance of the S&P Materials Select Sector Index. The fund, created in 1998, primarily holds large-capitalization U.S. basic materials companies. Chemical maker DowDuPont Inc. (DWDP) accounts for over 20% of the portfolio. XLB, with a huge asset base of $3.64 billion and offering a 2.20% dividend yield, is up 2.40% year to date (YTD) as of Jan. 22, 2019. The ETF charges a low 0.13% management fee and has received net inflows of $87.06 million in the past week.

XLB traded within a six-point range between February and September last year before tumbling 12.2% in the fourth quarter. The fund broke above the upper trendline of a descending channel Friday, which suggests further upside momentum. Traders who go long could set a take-profit order at either $56, $57 or $60 – all areas where the price may encounter overhead resistance. Consider managing risk by placing a stop slightly below the 50-day simple moving average (SMA).

Chart depicting the share price of the Materials Select Sector SPDR ETF (XLB)

Vanguard Materials ETF (VAW)

Formed in 2004, the Vanguard Materials ETF (VAW) attempts to offer similar performance to the MSCI US Investable Market Materials 25/50 Index. The fund, with assets under management (AUM) of $2.36 billion, invests across the market cap spectrum of U.S. companies that operate within the materials sector as classified under the Global Industry Classification Standard (GICS). VAW has a strong tilt toward the commodity and specialty chemicals subsectors, with combined portfolio exposure of nearly 50%. The ETF's tight 0.06% average spread and $31.21 million in daily dollar volume make it a suitable instrument for those who employ short-term trading strategies. As of Jan. 22, 2019, the fund has a low management fee of just 0.10%, pays a respectable 2.02% dividend and is up nearly 3.5% YTD.

The ETF's share price started to fall away in September before eventually bottoming out in late December. Since that time, the price has rallied nearly 14% and staged a breakout above the upper trendline of a descending channel. Those who take a long position could bank profits on a run to $124, where the fund finds resistance from a horizontal line, or set an upside target at the next significant resistance area at $130. Protect trading capital by placing a stop-loss order slightly below $115.

Chart depicting the share price of Vanguard Materials ETF (VAW)

ProShares Ultra Basic Materials ETF (UYM)

Launched in 2007, the ProShares Ultra Basic Materials ETF (UYM) seeks to provide two times the daily return of the Dow Jones U.S. Basic Materials Index. The benchmark index consists of companies involved in the production of certain metals, chemicals and paper products. Like XLB, the fund holds a sizable allocation in DowDuPont (20.06%). Other key stocks in the portfolio include Linde plc (LIN, 14.06%) and Ecolab Inc. (ECL, 6.12%). The ETF's 0.69% average spread makes it more suited to swing trading rather than day trading. As of Jan. 22, 2019, UYM has returned 6.54% for the year, holds $36.93 million in AUM and pays a 0.93% dividend yield. Its 0.95% expense ratio is in line with the 0.93% category average.

UYM's share price has traded within a clearly defined descending channel since late September that has established clear support and resistance zones. Price broke above the pattern's upper trendline Friday on above-average volume, indicating conviction from the bulls. Traders who buy at the current price should look for an initial move to $60, where the fund may find resistance from a horizontal line that connects several reactionary swing points. A move through this level may see price test the $65 area. Stops could sit at the mid-point of Thursday's candlestick.

Chart depicting the share price of the ProShares Ultra Basic Materials ETF (UYM)
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