ETF Talk: Profit with the Right Materials

The government-subsidized, 3.5% third-quarter growth in U.S. gross domestic product (GDP) announced last week may or may not be a true indicator that the economy is turning around. But if the recovery is real, it could send stocks of materials companies soaring. If, however, we see the economy stall, we could see a slide in cyclical stocks.

Whichever way cyclical stocks go, there are exchange-traded funds (ETFs) that can help you profit. The best of these ETFs are linked to the basic materials sector.

If you are bullish on materials, then the ProShares Ultra Basic Materials fund (UYM) might be right for you. The ETF seeks daily investment results, before fees and expenses, which correspond to twice (200%) the daily performance of the Dow Jones U.S. Basic Materials Index.

Look no further than this morning’s financial news if you want to make a bullish case for the materials sector. Investors rushed into stocks early today, after improved results on service industries and employment eased two of the biggest worries about the economy. 

On the other hand, a weak report on consumer sentiment and a drop in consumer spending sent stocks sliding last Friday. In fact, the market overall retreated last week, as well as yesterday. 

If you want to try to profit by going short on the materials sector during such market dips, you may want to consider the ProShares UltraShort Basic Materials (SMN). This ETF seeks daily investment results, before fees and expenses, which correspond to twice (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Basic Materials Index. However, the fund can be volatile. One example is its nearly 8% drop last Thursday, after the positive GDP report led some investors to conclude an economic recovery genuinely began in the third quarter. 

I personally am not sure what the real GDP number would have been without the government’s effort to stimulate the economy through the "cash for clunkers" program to fuel car sales, and the tax credit of up to $8,000 for first-time homebuyers. Consumer spending, which normally drives recoveries, is unlikely to climb much with the unemployment rate forecasted to top 10%. If shoppers retrench in the face of rising joblessness and tight credit, the fragile recovery could tip back into recession.

Even President Obama acknowledged last week after the release of the GDP numbers that "we have a long way to go to fully restore our economy" and recover from the deepest business slump since the 1930s-era Great Depression.

Mixed signals about the economic outlook came from Burlington Northern yesterday, as its CEO Matt Rose said that consumers will be the driver of any improvement in the economy, but he added that people aren’t buying yet. And coal shipments to power plants have dropped because of lower electricity demand.

Meanwhile, Burlington Northern also announced yesterday that Warren Buffett’s Berkshire Hathaway agreed to buy the nation’s second-largest railroad in a $26.3 billion deal that reflects long-term optimism about the U.S. economy. At least Buffett is a believer in long-term U.S. economic growth.

Clearly, a case exists to play the materials sector either way right now. If you want my advice about which ETFs to buy and sell, check out by ETF Trader service by clicking here. Remember, I am happy to answer your questions about ETFs. To send me a question, simply click here. You may just see your question covered in a future ETF Talk.