Mining ETFs: Ready To Rally?

by on May 26, 2010 | ETFs Mentioned:

Since the S&P 500 hit a 2010 high on April 23, global equity markets have battered by a wave of risk aversion that has sent many broad indexes down as much as 20%. The recent sell-off has impacted nearly every corner of the global economy; virtually every country and sector are in the red over the last month. But some areas have been hit harder than others. From a regional perspective, Spain and Italy have hit particularly rough stretches (EWP and EWI have lost 17.5% and 18.3%, respectively, since April 23).

Few sector ETFs have been beaten down in recent weeks as much as those offering exposure to the mining industry. The mining sector often functions as a leveraged play on the overall economy; as prospects dim demand for raw materials generally declines, thereby squeezing profit margins at mining companies. On the other hand, as demand for raw materials soars during bull markets, commodity prices tend to rise and additional revenue drops to the bottom line of firms responsible for extracting them.

But there has been another factor at work against mining ETFs in recent weeks. As turmoil in Europe and Korea has rippled through financial markets, investors have sold off risky assets and flocked to safe havens. This behavior has extended gold’s impressive run higher, but it has also breathed new life into the U.S. dollar, a currency suddenly viewed as the closest thing to “risk-free” available.

Dollar’s Gain = Commodity Loss

The euro’s plunge to new lows has dominated the headlines (see Three ETFs For Euro/Dollar Parity), but the greenback’s resurgence has come at the expense of other currencies as well. Over the last month, the dollar has surged against nearly every major rival, from the Australian dollar (up 11%) to the Swiss Franc (up 8%). Even countries in much better fiscal shape than the U.S. have seen their currencies lose ground; the greenback has climbed against both the Russian ruble and Chilean peso (see Three Country ETFs With Low Debt-To-GDP).

This sudden strength in the U.S. currency has exacerbated the pullback in commodity prices because many natural resources are priced globally in dollars, prices rise when the dollar falls, and vice versa. Declining commodity prices are of obvious concern to those engaged in production and extraction; lower market rates often translates into reduced profitability.

So the perfect storm has formed over miners over the last month; concerns about Europe’s drag on global growth have intensified while a suddenly strong dollar has added additional pressure to already plummeting commodity prices (Market Turmoil Boosts Long-Term Government Bond ETFs).

Mining ETFs: Bargain Buy?

Crude oil’s plunge has dominated discussions among commodity investors in recent weeks, as a slide below $70 as the summer driving season nears caught many by surprise (see What Oil ETFs Are Telling Us About Crude Prices). But oil isn’t the only commodity to sink over the last month; prices of everything from copper to zinc have dropped sharply. And mining ETFs have been hammered as a result.

Some investors are beginning to wonder if a rebound is imminent. The dollar’s climb against the euro may have some staying power–some see euro/dollar parity in the not-so-distant future–but the greenback may be hard-pressed to hold on to its gains against other currencies.

If the recent pullback has been a bit too harsh, mining ETFs (those not focusing exclusively on gold miners) could make for an interesting play in coming months. Below, we highlight three ETFs that offer exposure to this volatile but potentially rewarding sector (for more ETF ideas, sign up for our free ETF newsletter).

  • Dow Jones Emerging Markets Metals & Mining Titans Index Fund (EMT): One of the first sector-specific emerging markets ETFs, EMT offers exposure to mining companies involved in industrial and precious metal exploration, extraction, and production in the emerging world (see EMT’s technical analysis page).

  • Global X Copper Miners ETF (COPX): Whereas EMT and XME offer exposure to stocks engaged in the production of a variety of precious and industrial metals, COPX is more targeted. This relatively new ETF tracks the performance of the Solactive Global Copper Miners Index, a benchmark consisting of companies actively engaged in the copper mining industry (see COPX’s holdings).

Disclosure: No positions at time of writing.