Wednesday, August 26, 2009

Rude Awakening - The Second Coming of Natural Gas

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Rude Awakening

The Rude Awakening

Laguna Beach, California

Wednesday, August 27, 2009


* The growing gap between economic reality and Wall Street,

* Three beaten down stocks for your learned consideration,

* The ups and downs of opinion-making markets and more...


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Eric Fry, reporting from Laguna Beach, California…

Everything is up. That is all we know and, apparently, all we need to know to be an enthusiastic buyer of U.S. stocks.

Consumer confidence is up for the first time since May. National home prices are up for the first time since 2006. …And lest we forget to mention it, stock prices are up…a lot.

Up is good, right?

So, let's see; what else is up? Well, the federal deficit is up. So is long-term unemployment. So are mortgage foreclosures. So are credit card delinquencies.

Not everything is going up, of course. Some things are going down. But things that go down must also be good. Why else would the stock market have advanced more than 50% since March?

So let's take a look around and see what's going down. Well, interest rates are going down. That's good. Negative consumer sentiment is going down. And that's also good.

What else? Let's see…consumer lending is going down. So is manufacturing activity. So are retail sales. So are worldwide exports. So is the value of the U.S. dollar. So are corporate profit margins. So are federal tax revenues.

Hmmm…doesn't seem like great news. But somehow, the stock market converts headlines into "buy" orders. No matter how flimsy the fundamental rationale for buying stocks, the buyers still show up at 9:30 Eastern Time every day to buy the stocks they forgot to buy the day before. And just like that, you've got a great, big bull market…at least for a while.

Meanwhile, over in the commodity markets, prices are more "downy" than "uppy." During a normal economic recovery you would expect to see rising prices for the things that make the economy go round. But that's not happening. Weird. To be sure, some commodities, like copper, are rising in price. Sugar has also been a standout. But most other commodities are doing a whole lot of nothing…or worse.

The runt of the litter has got to be natural gas. No price is too low for this essential energy source. From the lofty heights of $13 per Mcf last summer, the natural gas price has plummeted to a seven- year low of $2.80. Where will this selloff end?

Chris Mayer, editor of Capital & Crisis, offers a few guesses…

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The Second Coming of Natural Gas
By Chris Mayer

Natural gas is in the dumps. And that is a good reason to own some. Cycles self-correct, and for natural gas, the self-correction process is already in the works.

Low natural gas prices, for example, are bringing in fresh demand from utilities. They are switching from coal, which is more expensive and comes with the added threat of new and as-yet- undefined carbon regulations. Natural gas production gives off about half of the carbon dioxide as coal. You can also build natural gas plants more quickly than coal plants. Natural gas is also cheaper to move. Therefore, power companies are upping the investment in natural gas. Already, coal-to-gas swapping has created incremental demand of 3 billion cubic feet per day.

The consensus is we'll have cheap gas for years. The firm Wood Mackenzie says natural gas prices won't recover until 2015. That's a pretty good crystal ball they got over there at Wood Mackenzie.

I think that prediction will be wrong.

Joe Rosenberg, the savvy chief investment officer at Loews Corp., a stock I have recommended to the subscribers of Capital & Crisis, has made a number of timely calls, including jumping on fertilizers in 2002. Today, two of his favorite investments are natural gas and gold.

He calls natural gas "one of the cheapest commodities in the world today and -- I would daresay -- one that over the next 10 years will be a very, very attractive commodity." I agree with Rosenberg. Cheap commodities have a way of becoming dear after a time.

"The best way to own natural gas," says Rosenberg, "is to have very long-term reserves of natural gas in the ground -- and not worry about it." Loews has 20-year reserves of natural gas through its subsidiary, HighMount.

Another way to play the rise in natural gas production is to own the stocks that do the drilling and make the equipment. I like Tesco (TESO:nasdaq), a solid play and a good shot at a triple from here. It basically makes the motors that power those drilling rigs working in the shale gas plays.

Robert Rodriguez, the great manager of First Pacific Advisors' Capital Fund, shares Rosenberg's bullish outlook for the energy sector. Rodriguez has been buying energy stocks all year. In fact, nearly 67% of his purchases in the last quarter were in energy. He added new positions and bolstered older ones. As he writes:

"In each case, we deployed capital in companies that have strong balance sheets with managements that have expressed a policy of living within their current cash flows. The E&P companies were acquired at valuation levels that are 20-40% less than the value of proved reserves, on a per share basis, than in 2002. We estimate that both the new and existing energy service companies were acquired at valuations that were approximately 30% of replacement cost." (Rodriguez's fund owns Ensco [ESV:nyse], for example, which is a stock I recommended several months ago in Capital & Crisis).

Bargain valuations are not the only appeal of the energy sector, according to Rodriguez. He also sees energy as a hedge against inflation. "We view the energy sector as both a store of value and a hedge against a future inflation," Rodriguez explains. "It is one of the few sectors where we believe the underlying fundamentals will continue to improve despite the worldwide economic contraction. With worldwide oil depletion rates of 9% annually for those fields past peak and U.S. natural gas first-year production decline rates of 30- 50%, these trends should be supportive of energy prices longer term. Again, within three-five years, we believe oil prices will be back above $100 or even higher than $150 per barrel."

I agree with Rodriguez. And while the price of oil has gone up a lot, the price of natural gas is scratching seven-year lows. So natural gas may be even better than oil, since it has not moved much, yet many of the same oil dynamics apply. Of the E&P companies Rodriguez added recently, most are heavy on natural gas. My favorite natural gas producer is Contango Oil & Gas (MCF:amex), which is still very cheap. It's also a debt-free and low-cost producer.

One of these days, natural gas will recover from its depressed prices. So why not avoid the rush. Buy now!

Joel's Note: If there's any value to be found in this market, expect Chris Mayer to sniff it out. We invite you, therefore, to check out his suggestions above, then check out his latest idea on how to invest in commodities, here.

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[Rude Endnote: Japan and China looked to be the standouts of trading overnight. Investors in the two countries bid up their respective indexes after Wall Street finished the day in positive territory yesterday. China's CSI 300 was up over 2% last we checked while Japan's Nikkei 225 had added about 1.3%.

In Europe, markets were just kicking off as we sat down to send you today's issue. Measures from the Thames to the Rhine were down between 0.3-0.4% but, as we mentioned, it was still early in the day to infer much.

What else?

Crude sloshed around at around $72 a gained a few bucks to $949 an ounce...and your editor, though he strongly suspects his drink was spiked last night, still managed to place second in cards…

Yep, that's it for today.

Until next time...


Joel Bowman

The Rude Awakening

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