Right about the time we were putting our money to work in oil, we noticed that commodities were starting to make a recovery as well.
The SPDR S&P Metals and Mining ETF (XME) appeared to have bottomed-out in late January 2016, but was still below our Buy Threshold at the end of February, making it worth a look.
The first question that immediately came to mind was whether there is a correlation between the energy and commodities recoveries.
In order to make an assessment, we need to first understand the composition of XME.
Steel dominates XME’s portfolio, making up more than half of the total holdings. Additionally, gold and silver also make up a significant portion of the portfolio at 20% of XME’s holdings.
Digging further into the data in the graph above, notice that XME started its recovery in January ahead of the energy recovery. So what drove this increase in value?
China, the world’s largest buyer of copper, coal, and iron ore, took advantage of the historic lows in commodities and made significant purchases. The increase in demand for these commodities, coupled with positive signs from the Chinese economy in early 2016, appear to have driven the upturn in metals and mining stocks.
But what about oil?
The energy sector accounts for about 10% of steel consumption in the US, using steel to construct rigs, pipelines, and oil country tubular goods (OCTG).
As oil peaked in 2014, the steel industry growth was modest, but steel demand from the energy sector grew in double digits. This dependency indicates a positive correlation between the steel corporations contained within the XME portfolio and the energy industry.
As a result, there were 3 good reasons that XME appeared to be a good opportunity while it remained below the Buy Threshold:
- The increased demand and positive economic data from China
- Positive signs of an energy recovery
- The energy sector’s significant impact on the steel industry
In late February, we purchased shares of the XME ETF.
Another ETF with inter-sector dependencies is the SPDR S&P Emerging Markets Dividend ETF (EDIV).
EDIV is dominated by the Taiwanese economy (29% of the portfolio) with South Africa and Brazil making up the next two largest economies.
Throughout the second half of 2015, emerging markets struggled, likely due to China’s economic problems.
Weak emerging market currencies, a strong U.S. dollar, and falling oil prices caused significant sell-offs in emerging market stocks.
Taking a look at the graph below, EDIV bottomed and started a recovery in mid-January 2016 in concert with the commodities recovery, and further bolstered by the energy recovery.
Additionally, one of the advantages of EDIV over other emerging market funds is its relatively high yield, paying out approximately 5% in dividends.
With EDIV’s large dependency on the Taiwanese economy, the historical volatility in commodities, and our current investments in energy and commodity ETFs, we decided to give emerging markets some time to develop a recovery.
After about 2 months of positive growth with EDIV still below our Buy Threshold, we purchased the ETF in early April.