10-Year Cyclicals Revealed in Treasuries?

Investors trying to divine the next move in certain cyclical stocks may need to
look no further than the 10-year Treasury note. The correlation between the
chart pattern of the 10-year yield and that of the aluminum, coal, nonferrous
metals, and steel sectors has been at an extraordinarily high level in the past
year. This indicates that the ability of these four sectors to sustain their
recent rally may require confirmation from the 10-year. So far, that isn't
happening which may be a negative sign for stocks in these groups. The three
charts below show the extent of the connection between the benchmark T-note and
the performance of aluminum, coal, and nonferrous metals. Dow Jones U.S.
Aluminum Index (DJUSAL) Dow Jones U.S. Coal Index (DJUSCL) Dow Jones U.S.
Nonferrous Metals Index (DJUSNF) Steel also has shown a high correlation with
the 10-year yield during the past 12 months, but it has experienced a stronger
positive divergence of late. Dow Jones U.S. Steel Index (DJUSST) It stands to
reason that the 10-year yield would track the stock prices of cyclicals since
stronger economic growth is a catalyst to drive both higher. Indeed, a look at
the longer-term charts on the sectors discussed here shows that while there have
been periods of divergence, all tend to follow longer-term Treasury yields
fairly closely over time. The tight correlation of the past year could be
expected at a time in which macroeconomic concerns have been the primary driver
of asset prices, but investors can nevertheless use the connection between bonds
and cyclicals to their advantage in two ways: First, the fact that the 10-year
yield has held stubbornly under 2% thus far in 2012 serves as a potential
warning for short-term investors since steel, aluminum, nonferrous metals, and
coal have all provided investors with stellar returns year-to-date. If there
isn't a confirmation from the 10-year soon, it may be an indication that the
recent move in these four sectors is just a head fake. We may be nearing the
point where something has to give since Tuesday and Wednesday brought robust
performance for the four sectors even as the 10-year fell from 1.96% to 1.90%.
Second, a convincing move above 2% would be a very bullish sign for these market
segments with "convincing" being the operative, and problematic, word.
Since falling under 2% in early September, the 10-year has made no fewer than
eight attempts to pass this key level, and it has failed on each occasion. On
one of these attempts, the 10-year spent virtually the entire month of October
above 2% before failing on the first day of November. The takeaway: This is an
indicator that can produce some confusing signals. Still, it's clear from the
charts above that government bonds should be a primary focus for anyone who is
considering a trade in these four sectors. Below are some of the stocks in each
sector that have an above-average correlation with the 10-year Treasury note:
Aluminum Alcoa (NYSE: AA ) Aluminum Corp. of China (NYSE: ACH ) Century Aluminum
(NASDAQ: CENX ) Coal Peabody Energy (NYSE: BTU ) Walter Energy (NYSE: WLT ) Arch
Coal (NYSE: ACI ) Nonferrous Metals Freeport-McMoRan Copper & Gold (NYSE: FCX )
Teck Resources Ltd. (NYSE: TCK ) Steel Vale (NYSE: VALE ) Arcelor Mittal (NYSE:
MT ) U.S. Steel (NYSE: X ) Steel Dynamics (NYSE: STLD ) AK Steel (NYSE: AKS )