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There is no shortage of natural gas bears in the investment
community. Natural gas prices have been falling for months and
so far bearish bets have paid off.
But if they're smart, the bears will take their profits now and
hibernate for the rest of the year. Natural gas has bottomed and
is ready to rally - big time.
Of course, the bears will argue otherwise. But they're wrong...
They're letting logic cloud their thinking and it's blinding
them to the opportunity in front of them.
Logic says there is a glut of natural gas the market. Logic
dictates the oversupply of natural gas should pressure prices
lower until the forces of supply and demand deal with the glut.
And logic is correct.
What the bears are missing here, though, is the market already
knows this. The market knows there's a glut. The market knows
natural gas prices have to move lower to correct the
supply-and-demand imbalance. And the market has already
responded.
Last week, natural gas prices dropped as low as $3.50 per
million British thermal units (BTUs). That's as low as prices
have been in nearly seven years. In fact, $3.50 is widely
regarded as the "shut in" price for natural gas. That's the
price at which natural gas drillers are better off closing down
the well than continuing because it costs more to extract the
gas than what the drillers can sell it for.
In other words, natural gas cannot fall much below $3.50
before drillers start shutting wells. Once that happens, the
forces of supply and demand start going the other way. And
the market knows this...
Which is why natural gas bounced off of the $3.50 price
level and is now trading at $3.86. The market has already
discounted the natural gas supply glut. It started
discounting it in the fourth quarter last year when, for the
first time in a decade, natural gas prices fell during the
last three months of the year.
Now the market is ready to start discounting a drawdown in
natural gas supplies. The drawdown won't happen immediately.
Heck, it may not happen for several more months. But the
market is a discounting mechanism. Prices will start to
increase well before the fundamental factors support such a
move.
We should soon see natural gas prices begin to trade more in
line with their historic relationship with oil.
As you can tell from the following chart, it now takes
roughly 15 million BTUs of natural gas to buy one barrel of
oil...
Historically, this ratio has trended around 10. In fact, for
most of the past decade, the ratio has been closer to eight.
The current 15-to-1 ratio is the most extreme reading of the
past 20 years. This means one of two things has to be true:
Either oil is too expensive or natural gas is too cheap.
If oil is too expensive, then oil prices will fall while
natural gas holds steady. If natural gas is too cheap, then
there's the potential for a huge rally in the works.
Either way, the downside to buying natural gas right here is
limited and the upside is huge.
Best regards and good trading,
-- Jeff Clark
Editor's note: Veteran options trader Jeff Clark keeps tabs
on the market's best trading opportunities in Growth
Stock Wire, a free daily e-letter. To get Jeff's guide
to options,
click here.
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