The Upward Convergence of Natural Gas Will Remain Difficult to Play
Stay away from long-only products.
I concluded January 2011's Divergence of Crude Oil and Natural Gas Widens:
That, I am proud to say, came under the category of good advice; the total returns for two of the worst investment products ever created by the mind of man or beast, the US Oil Fund (USO) and US Natural Gas Fund (UNG), since that time have been -7.03% and -62.61% at the time of this writing.
However, just as the cure for high prices is high prices, the cure for low prices is low prices. The massive delivery-market discounts for natural gas -- not only for commercial and industrial users in competition with petroleum products but increasingly in utility markets in competition with coal -- will have their effects. I shudder when I see utilities abandoning coal for natural gas if for no other reason than the fact that I have seen many a natural gas price spike and have yet to see one for coal. The buy-high / sell-low crowd will lose on this switch because that is always the end result of this strategy. And as for the supply side, just wait until all of the must-drill wells from the likes of Chesapeake Energy (CHK) disappear.
Please be advised, though, that playing rising natural gas prices is not to be confused with shooting fish in a barrel, as if anyone ever has shot a fish in a barrel; this sounds like very unbalanced behavior to me. Let's take a look at the long-term return paths of the Dow Jones-UBS crude oil and natural gas indices going back to 1991. These indices are part of the broader index of long-only commodity products sold originally with the promise that they would capture a positive monthly roll yield from futures in backwardation (inversion). Right -- a $100 position in the natural gas subindex in January 1991 would have been worth $1.85 on April 19, 2012. This is equivalent to throwing your money into the caldera of an active volcano and far less entertaining.
What is critical to remember, though, is that natural gas was in a secular uptrend until 2008 or so. If we use the peak of the crude oil market in July 2008 as a benchmark date, that same $100 in January 1991 was worth $1,656 in crude oil but only $54 in natural gas. The spot return in natural gas over the same period was 12.0%. Restated, you lost money with a long position in a bull market by virtue of negative roll yield.
As the seasonality of natural gas in unlikely to be repealed anytime soon, the fondest wishes of the global warming crowd notwithstanding, any long position in natural gas will face the same hurdle going forward as it did between 1991 and 2008. Stay away and do not look back.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter