Resource Plays: Steel, Copper & Oil

11/05/2004 12:00 am EST

Focus:

Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer has an uncanny knack for putting investors in the right sectors at the right time. A trio of recommendations in his latest The Options Advisor focuses on the natural resource sector, offering plays on steel, copper, and oil.

"Bearish sentiment remains high toward steel maker, Nucor (NUE NYSE). The put/call open interest ratio indicates rising pessimism among options traders. Short sellers are also active, and it would now take more than four days to cover the 11.1 million NUE shares sold short. This accumulation of bearish positions accounts for more than 7% of the stock's total float and thus could provide ample fuel for a short-covering rally. Wall Street has taken a pessimistic stance toward NUE, with eight of the 11 covering analysts rating the shares a ‘hold’ or worse. Any upgrades from this dour group could be a boon for the equity. On the technical front, the security is now resting on its ascending 20-week moving average. The shares have not closed a week below this trendline since May, making this an excellent entry point for the trade. For options traders, we recommend buying the Nucor January 2006 37.50 call.

"After a great run higher during the summer, the price of copper pulled back for a successful test of its 10-month trendline. With strong support now bolstering the metal, mining company Phelps Dodge (PD NYSE) stands to gain from a rebound. What's more, PD is also perched on the steadfast support of its ascending 10-month moving average, which the equity hasn't closed a month below since April 2003. Investors have shrugged off the security's impressive technical strength and appear confident that the stock has reached a top. What's more, nearly 6% of the equity's short interest has been sold short. An unwinding of these bearish bets could help fuel a rally in the shares. In light of PD's technical strength, such investor skepticism has bullish implications from our contrarian perspective. Options traders should buy the Phelps Dodge January 2006 85 call.

"With crude oil prices trading near all-time highs, the oil services sector continues to be a key group. One particularly strong performer is Smith International (SII NYSE), which has outperformed its peers in the PHLX Oil Services Sector Index since August 1998. Furthermore, the security has rallied along its 10-month moving average since July 2002. Investors appear convinced that this rally is nearing an end, however, as bearish bets pile up against the stock. The number of SII shares sold short gushed 15% higher in September to 6.7 million. This accumulation of shorts accounts for nearly 9% of the equity's total float and could send the shares shooting higher if traders are forced to buy back their positions. Brokerage firms are also skeptical, with 13 of the 20 analysts following SII rating it a ‘hold’ or worse. Any upgrades from this grim group could push the security higher. Options traders should buy the Smith International January 2006 55 call."

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