Wait For Pullback to Buy Red-Hot Metals

Steel and industrial metal plays rocketed to multi-month and multi-year highs in December, posting their strongest gains of 2017 in reaction to copper's rapid ascent to a four-year high. This bullish action bodes well for 2018, but major instruments are now overbought and in need of consolidation that shakes out weak hands while setting the stage for additional upside in the coming months.

Higher inflation expectations are driving this dramatic uptick, along with rising optimism that the White House and Republican Congress will soon pass a massive U.S. infrastructure package. Bullish Chinese GDP data are adding to this harmonic convergence, raising the odds that deep 2016 lows marked cyclical bottoms ahead of long-term uptrends that could eventually reach new highs. (See also: Beyond Gold: Top Picks in Industrial Metals.)

The SPDR S&P Metals and Mining ETF (XME) hit a three-year high at $77.44 in 2011 and entered a steep decline that found support at $32 in 2013. A bounce into 2014 stalled at a lower high, yielding a breakdown through the 2008 bear market low in November 2015, with selling pressure continuing into January 2016's all-time low at $11.38. It remounted broken support three months later, signaling a potential long-term bottom.

The uptick stalled at the broken 2013 low in February 2017, generating a rounded correction that held 200-day exponential moving average (EMA) support, while the rally into year end pierced that barrier and has nearly reached the .786 Fibonacci retracement level of the 2014 into 2016 decline. This price zone stands as the final barrier, ahead of a rally thrust that should reach the mid-$40s, raising the odds for a first quarter pullback and consolidation that could test new support at $33.50. (For more, see: Investing in the Metals Markets.)

Freeport-McMoRan Inc. (FCX) shares reached the 2008 high in the lower $60s in January 2011, completing a V-shaped reversal, and sold off into support in the upper $20s. That level held into a 2014 breakdown that accelerated through 2015, dropping the stock to a 15-year low in January 2016. It bounced into the mid-teens a few months later and stalled out, entering a shallow rising channel that tested the breakdown through support at the January 2015 low at $15.43.

The stock exploded off channel support in December, gained ground into year end and is now trading about 1.5 points under channel resistance. That barrier also marks the 200-month EMA, signaling limited upside and adverse reward:risk for new long positions. This price structure also suggests that the rally will stall at or near $20, yielding an intermediate correction that could offer a historic buying opportunity if it reaches the $15 to $16.50 price zone. (See also: Assessing Freeport-McMoRan and Rio Tinto.)

United States Steel Corporation (X) stock hit an all-time high at $196 in 2008 and plunged with world markets during the economic collapse. It bottomed out at $16.66 in March 2009, with that level holding firm into a September 2015 breakdown that reached the lowest low since the steelmaker's current incarnation began in 1991. It remounted broken support in the second half of 2016 and reversed in February 2017 at 200-month EMA resistance in the mid-$30s.

The stock posted a higher low at $18.55 in May 2017 and turned higher once again, accelerating to the upside in December along with other industrial metal plays. The rally has now reached within two points of the .786 sell-off retracement at $37, signaling limited upside along with growing odds for a pullback that could undercut psychological support near $30. A long position taken around that level could benefit from a rapid recovery and eventual breakout above a seven-year declining trendline with resistance now centered near $39. (For more, see: Top 4 Steel Stocks for 2018.)

The Bottom Line

Strong December price action in the industrial metals sector predicts outsized 2018 returns, but the rally is now approaching resistance that should trigger multi-week pullbacks and tests of new support. (For additional reading, check out: Using Base Metals as an Economic Indicator.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>