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This Commodity Is Super Cheap... and 100%+ Gains Are on the Way

By Chris Mayer, editor, Capital & Crisis
Saturday, June 20, 2009

It's a tough market to want to buy something. 

As I write, the market has rallied 36% since its lows on March 9. 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
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 U.S. gas situation looks like. 

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. 

Natural Gas Is Too Cheap
Natural Gas Is Too Cheap

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. 


Chris Mayer 

P.S. I just told readers of my Special Situations advisory about a potential four-bagger opportunity in natural gas. It's a debt-free and low-cost producer that is still profitable even at these low prices... and it trades for half of the value of its proven and probable reserves. Add in a huge land position, and you have a stock that's potentially worth four times what it's trading for today. You can learn more about a Special Situations subscriptionhere.

Market Notes



We're borrowing an idea from our colleague Jeff Clark for our chart of the week...

Jeff is one of the few traders we've ever seen who consistently trades the short-term movements in gold stocks for profit... so we always pay attention to his opinions on the sector.

Just a few days ago, Jeff updated his readers on his "wish price" to buy more gold stocks. As you can see from this week's chart of the gold miners fund (GDX), gold stocks are in a confirmed uptrend since last December. Each time they dip down to their trendline, they tend to rally higher.

Jeff's target buy price to get the GDX "on sale" is around $33. If you're looking to trade gold stocks, keep an eye on that number.

– Brian Hunt

In The Daily Crux

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