It’s a tough market to want to buy something.
As I write, the market has rallied 36% since its lows on 9 March. Many individual stocks are hundreds of percent higher.
This kind of pattern is common even in the worst of markets. By now, you’ve probably heard how the market rallied 41% in early 1930 after the crash of 1929. Yet the market went on to make new lows and had years of hard slogging ahead of it.
I’m not saying this is 1930, but I am picking my way carefully across the valley. I believe I’ve found a great place to hide – in natural gas.
Natural gas is more than a place to hide. It is, simply put, super cheap. As most other commodities – including oil – have rallied, natural gas remains stuck in a bog. In fact, the ratio of the price of crude oil to the price of natural gas topped 18-to-1 recently, which we have not seen since 1990, according to Barron’s. See the chart below, which shows you what’s happened to natural gas over the last year.
Natural gas: like jumping off a cliff in Acapulco
That’s cheesed off a lot of investors in natural gas producers, since stock prices in these things took a very similar swan dive. But I’m telling you, don’t let that discourage you. There hasn’t been a better time to buy a natural gas producer in years.
First, let’s begin by acknowledging that the price of natural gas fell because there was too much of it. We are in a recession, after all. Industrial demand for natural gas has fallen through the floor and into the basement. But mindless zombies or congressional leaders (I repeat myself…) do not run this industry.
Producers are cutting back. And the decline rates on gushing new shale gas plays (which helped contribute so much gas to the pool) are 60%-75%. If these producers don’t drill, the flow of gas from their wells will fall by that much in the first year.
And they aren’t drilling, not as much. The rig count has collapsed. It has fallen much faster than in the 1981-82 collapse, the worst since the Great Depression and one that still makes old natural gas men cringe to this day.
Another point: The marginal cost to produce natural gas for the vast majority of the industry is probably somewhere around $6-$8. This next chart gives you a good snapshot of what the US gas situation looks like.
Natural gas is too cheap
The key to this chart is to see how the spot price of natural gas bounces off that cash cost line. No one makes any money below cash costs, and you are not likely to stay there for long. Likewise, you see demand for natural gas drop when it gets to the upper dotted line. The marginal cost is the predictor to watch, though. Most of the time, the natural gas price will gravitate toward that line.
Right now, the spot price of natural gas is under $4 and sits right on the industry’s cash costs and well below marginal costs. In short, natural gas supply is going to start to dry up here really soon. Grab your natgas ideas before the rush. Many producers will rise at least 100% in the coming year.
• This article was written by Chris Mayer, editor of Mayer’s Special Situations , for the free daily investment newsletter DailyWealth , and was first published on 20 June 2009