You Might Be Crazy to Buy This ETF Or It Might Really Work

The Materials Select Sector SPDR XLB is down 13.7 percent this year, making it the second-worst performer among the nine sector SPDRs. The Market Vectors Coal ETF KOL, Market Vectors Gold Miners ETF GDX and the Market Vectors Steel ETF SLX are lower by 44.5 percent, 21.2 percent and 36.4 percent, respectively.

With those data points in mind, it might seem like a death wish for a trading account to become involved with a metals and mining ETF of any type, let alone one that is heavy on gold miners, coal miners and steel producers.

Mr. Market seems to believe as much as the SPDR S&P Metals and Mining ETF XME has shed 43.2 percent this year. XME's woes are easily explained. The ETF allocates nearly 48 percent of its weight to steel stocks and as if that is not bad enough, the fund devotes a combined 17.6 percent of its weight to coal and gold miners.

Again, it might be crazy to get involved with an ETF like XME even at that 43 percent tumble, but some traders apparently see upside in the moribund fund as evidence by some unusual upside call buying in the fund last week.

On Thursday “we saw action in infrequently traded XME (SPDR S&P Metals & Mining, Expense Ratio 0.35%) options, consisting of January 20 calls trading more than 20,000 times. Given XME’s $16 handle at the moment these options are more than 16% out-of-the-money, but then again XME had a $20 handle just one month ago in the beginning of September before falling to current levels,” said Street One Financial Vice Paul Weisbruch in a recent note. 

For one day at least, XME bulls looked smart as the ETF surged 4.6 percent last Friday, a day after that unusual call buying was spotted. As contrarian trade, XME merits consideration by the trader that believes in the mantra of be greedy when others are fearful.

If old investing maxims are not one's cup of tea, one should consider the fact that relative to its recent track record, the Market Vectors Gold Miners ETF is starting to look pretty good. The largest gold miners ETF jumped more than eight percent last Friday and now resides above its 20- and 50-day moving averages.

Improvements in GDX are important to XME because was noted earlier, the latter devotes 10.3 percent of its weight to gold miners. Additionally, silver and other precious metals miners combine for almost another 13 percent of XME's lineup and four precious metals miners are found among XME's top 10 holdings.

Following Friday's close at $17.33, XME would need to gain 15.4 percent by January options expiry to bring the aforementioned calls to a point where profitability can be discussed. Given XME's penchant for volatility, it is possible these options could be winners. The S&P Metals and Mining Select Industry Index, XME's underlying index, has a five-year standard deviation of 35.45 percent compared to 15.15 percent for the S&P 1500, according to Standard & Poor's data.