This strategist says Australia's materials sector is looking 'just a little too hot right now'

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If the rally in commodity markets this year has got you excited about the outlook for Australian mining stocks, Chris Weston, chief market strategist at IG Markets is Melbourne, has a word of caution for you.

In a research note released on Monday, Weston says that some commodity markets are “just a little too hot right now,” a view that few will disagree with given the enormous gains in bulk and base commodity prices over recent months, particularly for iron ore, coking and thermal coal.

“The materials space has been where the short-term traders have been active all year, especially those who focus on trend and momentum,” says Weston.

“That bring said, the outperformance in this space is now so great that for those who are cautious when others are greedy then this sector is one that is just a little too hot right now.

“Year-to-date Australia’s materials sector has gained a massive 38.5%, relative to energy, the next best performer, with move of 3.6%,” he adds.

While spot prices for iron ore and coking coal continued to rip higher on Friday, closing at fresh cyclical highs, Weston hasn’t been convinced by some of the price action in other commodity markets, adding to his caution.

“Look at the price action in copper on Friday,” he says.

“Price traded to $US2.73/lb, but subsequently fell a massive 8.3% into the close – how telling is this reversal?

“Much has been made of moves in iron ore, with spot closing up 7.7% on Friday, but importantly steel futures lost 1.6% and I would be look closely at this commodity as a leading indicator this week.”

Steel prices — whether in physical, spot or futures markets — has led the rally in other bulk commodity markets in 2016, laying the foundation for some of the astronomical gains in iron ore, coke and coking coal prices, key steelmaking ingredients.

Outside of the recent price action, Weston is doubly cautious given Chinese new bank lending figures for October — released over the weekend — were substantially weaker-than-expected.

“New CNY loans for October dropped from RMB1.22 trillion in September to RMB651 billion,” he says.

“This would largely cement a growing view that monetary policy in China is tightening somewhat given the rising risk of asset bubbles.

“One could argue this is another reason to take a slightly more cautious view on the materials space.”

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