Bernie Bets on Biotech

02/24/2006 12:00 am EST

Focus:

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

"One market segment that caught my eye because of its technical prowess of late is biotechnology," says Bernie Schaeffer. Here he looks at ways to play the biotech sector via exchange traded funds and through a five-pack of individual stocks.

"The iShares Nasdaq Biotechnology (IBB ASE), an exchange traded fund, is perched at new multi-year highs. BTK has been in rally mode for nearly a year, gaining more than 50% since last March along the support of its ten-week and 20-week moving averages. The index is now trading near its highest point since November 2000. The exchange traded fund has gained 33% since late April and is challenging its April 2004 high in the 85 region.

"Turning to the ever-important sentiment front, IBB stands to benefit from the action of short sellers. After a 24% increase in shorted shares last month, the fund now shoulders a short-interest ratio of nearly ten days to cover. Should the fund make quick work of overcoming the 85 threshold, some of the bears may choose to exit the playing field by repurchasing their shorted positions.

"This activity, known as short-covering, fuels additional upside in the underlying issue, which then begets even more short covering.Options traders have also failed to let go of their skeptical outlook toward the biotech group. Looking at the open-interest configuration for the newly front-month March series, the dominant site of open interest is the out-of-the-money 80 strike. The 38,278 puts currently open at this strike represent potential structural support going forward.

"Also notable for the biotech group is how the mutual-fund flow activity has had bullish implications for quite some time. Investors in the Rydex Sector Select Biotechnology Fund (RYOIX) started bailing out late last summer, as the fund itself consolidated sideways. In fact, total assets in the fund stand at $147.9 million. That's a long drop from the fund's all-time peak (in March 2000) of $1.39 billion. Fidelity Select investors have also shown little respect for the biotech group. Over the short and intermediate terms, assets have been funneling out of the Fidelity Biotechnology Fund (FBIOX), even while the fund itself has been moving higher.

"If you decide to use IBB in your portfolio, one thing to be wary of is the 16.3% weighting of chief component Amgen, as I'm not wild about this large-cap's chances in the near term. But there are two newly established ETFs that resolve this disparity, keeping Amgen at a relatively equal weight with its peers. PowerShares has introduced the Dynamic Biotechnology & Genome Portfolio (PBE ASE) , and there is now a SPDR Biotech ETF (XBI ASE) in play. These are not yet actively traded, and are fairly new to the public trading world, but they are definitely worthy of a place on an active trader's radar screen.

"If you prefer individual equities, there are lots of smaller-cap biotech names that enjoy the solid contrarian recipe of strong price action and negative sentiment. I see a handful of biotechs that may have considerable upside potential. Gilead Sciences (GILD NASDAQ), Celera Genomics (CRA NYSE), Cephalon (CEPH NASDAQ), Celgene (CELG NASDAQ), and Human Genome Sciences (HGSI NASDAQ) all trade above their respective long-term trendlines, with GILD and CELG showing the most short-term technical prowess. The combination of improving price action set against a backdrop of skepticism bodes well for this quintet of names."

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