China Trumps Europe, Sending Materials Higher

Right now, the consensus trading playbook looks something like this: if you think Europe is getting better, buy the banks. If you think that China is getting better, buy the materials.

Here, we’ll focus on the second scenario, in which a Chinese economy slows, but remains in growth-mode, continuing to provide demand for a wide range of industrial products and basic materials. This is the narrative that has stocks like Alcoa (NYSE: AA) up by more than 17% over the past month and stocks like U.S. Steel (NYSE: X), gaining nearly 18%. Both of these gains are more than double the performance of the S&P 500 over the same time.

A handful of industrial materials companies are scheduled to report quarterly earnings on Thursday. These include Freeport McMoran Copper & Gold (NYSE: FCX) and Insteel Industries (NASDAQ: IIIN). It will be worth watching to see how traders and investors react to the reports from these companies, particularly as these reports will arrive in a generally bullish climate for materials names.

Heading into Thursday, shares of Freeport are back at overbought extremes below the 200-day moving average. The stock has closed higher for six out of seven trading days, four of which have been at overbought levels. FCX has been trading in bear market territory since August, and the shares have earned “consider avoiding” ratings of 2 out of 10.

Also at short-term overbought extremes, Insteel Industries has finished higher for five out of six trading days and are back above their 200-day moving average. Shares of IIIN have been toiling away below the 200-day moving average since mid-July, and spent most of the second half of 2011 in a relatively wide trading range. The rally in IIIN comes as the stock makes a second attempt to sustain a breakout from that multi-month range.

Traders looking for larger short-term edges in this space may want to consider the pullback in CF Industries (NYSE: CF). A member of the agricultural chemical industry, CF Industries sold off by well over 2% to finish with a “consider avoiding” rating of 2 out of 10.

One of the easiest ways to get exposure to any potential downside in this sector is through inverse and inverse leveraged ETFs like the ProShares UltraShort Materials ETF (NYSE: SMN). Designed to track two times the inverse of the daily returns of the Dow Jones U.S. Basic Materials INdex, SMN began trading on Wednesday with a “consider buying” rating of 8 out of 10 only to have that rating upgraded by session’s end to a 9 out of 10.

Want more stocks? Read our latest from 7 Stocks You Need to Know: Volatilty and Visa’s New High.

David Penn is Editor in Chief of TradingMarkets.com