Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
The AI Mega-trend Stocks Investing - When to Sell? - 28th May 20
Trump vs. Biden: What’s at Stake for Precious Metals Investors? - 28th May 20
Stocks: What to Make of the Day-Trading Frenzy - 28th May 20
Why You’ll Never Get Another Stimulus Check - 28th May 20
Implications for Gold – 2007-9 Great Recession vs. 2020 Coronavirus Crisis - 28th May 20
Ray Dalio Suggests USA Is Entering A Period Of Economic Decline And New World Order - 28th May 20
Europe’s Coronavirus Pandemic Dilemma - 28th May 20
I Can't Pay My Payday Loans What Will Happen - 28th May 20
Predictive Modeling Suggests US Stock Markets 12% Over Valued - 27th May 20
Why Stocks Bear Market Rallies Are So Tricky - 27th May 20
Precious Metals Hit Resistance - 27th May 20
Crude Oil Cuts Get Another Saudi Boost as Oil Demand Begins to Show Signs of Life - 27th May 20
Where the Markets are heading after COVID-19? - 27th May 20
Silver Springboards Higher – What’s Next? - 26th May 20
Stock Market Key Resistance Breakout Is Where the Rubber Meets the Road - 26th May 20
5 Ways To Amp Up Your CFD Trading Today - 26th May 20
The Anatomy of a Gold Stock Bull Market - 26th May 20
Stock Market Critical Price Level Could Soon Prompt A Big Move - 25th May 20
Will Powell Decouple Gold from the Stock Market? - 25th May 20
How Muslims Celebrated EID in Lockdown Britain 2020 - UK - 25th May 20
Stock Market Topping Behavior - 24th May 20
Fed Action Accelerates Boom-Bust Cycle; Not A Virus Crisis - 23rd May 20
Gold Silver Miners and Stocks (after a quick drop) Ready to Explode - 23rd May 20
3 Ways to Prepare Financially for Retirement - 23rd May 20
4 Essential Car Trade-In Tips To Get The Best Value - 23rd May 20
Budgie Heaven at Bird Land - 23rd May 20
China’s ‘Two Sessions’ herald Rebound of Economy - 22nd May 20
Signs Of Long Term Devaluation US Real Estate - 22nd May 20
Reading the Tea Leaves of Gold’s Upcoming Move - 22nd May 20
Gold, Silver, Mining Stocks Teeter On The Brink Of A Breakout - 21st May 20
Another Bank Bailout Under Cover of a Virus - 21st May 20
Do No Credit Check Loans Online Instant Approval Options Actually Exist? - 21st May 20
An Eye-Opening Perspective: Emerging Markets and Epidemics - 21st May 20
US Housing Market Covid-19 Crisis - 21st May 20
The Coronavirus Just Hit the “Fast-Forward” Button on These Three Industries - 21st May 20
AMD Zen 3 Ryzen 9 4950x Intel Destroying 24 core 48 thread Processor? - 21st May 20
Dow Stock Market Trend Analysis and Forecast - 20th May 20
The Credit Markets Gave Their Nod to the S&P 500 Upswing - 20th May 20
Where to get proper HGH treatment in USA - 20th May 20
Silver Is Ensured A Prosperous 2020 Thanks To The Fed - 20th May 20
It’s Not Only Palladium That You Better Listen To - 20th May 20
DJIA Stock Market Technical Trend Analysis - 19th May 20
US Real Estate Showing Signs Of Covid19 Collateral Damage - 19th May 20
Gold Stocks Fundamental Indicators - 19th May 20
Why This Wave is Usually a Market Downturn's Most Wicked - 19th May 20
Gold Mining Stocks Flip from Losses to 5x Leveraged Gains! - 19th May 20
Silver Price Begins To Accelerate Higher Faster Than Gold - 19th May 20
Gold Will Soar Soon; World Now Faces 'Monetary Armageddon' - 19th May 20

Market Oracle FREE Newsletter

Coronavirus-stocks-bear-market-2020-analysis

An Extreme Investment Profit Opportunity in Oil and Natural Gas

Commodities / Natural Gas Mar 24, 2010 - 09:33 AM GMT

By: Q1_Publishing

Commodities

Best Financial Markets Analysis ArticleThe last time this happened, investors had the chance to pocket 83% gains in about four months time.

They could have done it safely. This has nothing to do with the overall market direction.


Best of all, it’s consistently lucrative. It has paid off an average of 112%.

But it doesn’t happen often. This opportunity has only arisen three times in the last five years.

Right now it’s about to happen all over again. Here’s the set up.

Physics 101: Energy is Energy

Oil prices have been steadily climbing over the last few months.

Since the start of the year oil prices have climbed more than 5%. The combination a recovery in demand, OPEC successfully capping output, turmoil in Iran, and artificially low interest rate-fueled speculative buying has pushed oil above $80 a barrel.

Natural gas, on the other hand, hasn’t fared nearly as well.

Large stockpiles, exceptionally warm weather, and a host of other factors have helped push natural gas prices down. So far this year natural gas prices are down 28%.

A situation where oil prices go up and natural gas prices go down cannot and will not last.

You see, oil and natural gas are highly correlated over the long run.

It’s basic physics. Oil and natural gas are both hydrocarbon energy sources. When they are burned they produce a certain amount of energy.  The energy values of each do not change. The energy value of a barrel of oil has always been the equivalent of about six thousand cubic feet (Mcf) of natural gas.

As a result of the value of the energy, oil and natural gas prices have been highly correlated over the long run.

The short-term, however, is a much different story. Sometimes events like cold weather, hurricanes, or other factors push natural gas prices higher and oil holds steady. Other times oil prices will climb when OPEC cuts production or during periods of heightened geopolitical turmoil while natural gas prices hold steady.

Since oil and natural gas prices are so volatile, the ratio of oil and natural gas prices varies greatly.

This volatility naturally creates opportunities. And it creates great opportunities for disciplined investors patient enough to wait for the extreme situations.

Right now, the oil and natural gas markets have hit one of those extremes.

Reaching Extremes

The long-run oil/natural gas ratio tends to stay within a range between 6-to-1 and 12-to-1. That means the price of a barrel of oil is usually is the same as six to 12 Mcf of natural gas.

Occasionally it steps out of that range. But, as the chart below of oil/natural gas ratios shows, the ratio always returns to that range over time.

As you cans see, the range has been volatile over the years.

Sometimes the ratio is too high and sometimes it’s too low.  Every time it has gotten very far out of line, it always returns to the range.

For example, the red arrow to the left shows what happened when Hurricane struck the Gulf of Mexico. At the time oil prices climbed.

But natural gas prices soared. The oil/natural gas ratio fell to 5-to-1 as natural gas prices outpaced oil prices.

The situation did not last. And it created a great hedge opportunity for investors to make 120% over the next few months as the ratio climbed from 5-to-1 to 11-to-1.

The second red arrow shows when the oil/natural gas ratio fell to the bottom of the range at 6-to-1. At that time the credit crunch sent the markets into a tailspin. Between July and October 2008, oil prices fell 70%. Natural gas prices, meanwhile, only fell 50% from their highs.

Once again, the extreme situation where natural oil was falling much faster than natural gas created another situation where investors could turn a nice, quick profit betting the ratio would return to its norms. IN this case the ratio rebounded from 6-to-1 to 14-to1 in four months. That would have been good for a 133% profit.

Then the green arrow in the chart shows what happened as the markets recovered from the credit crunch. An unseasonably warm winter pushed natural gas prices to eight year lows and a speculative run-up in oil prices pushed the ratio to more than 22-to-1.

Oil prices were too high and natural gas prices were too low. This was the most extreme point the ratio has reached in the past decade. And it was the big reason we started getting extremely interested in natural gas at the time.

As has happened every other time the ratio reached an extreme high or low, it reverted to the mean.

 In this case, oil prices continued to climb, but natural gas prices more than doubled from their lows. As a result, the oil/natural gas ratio went from an unsustainable 22-to1 down to 12-to-1 in the next four months.

Investors who themselves correctly walked away with a relatively safe 83% gain as the ratio reverted to the mean.

Now it’s shaping up to happen all over again.

Something Has to Give

The oil/natural gas ratio has hitting another extreme. 

As I write, the ratio is sitting at an unsustainable 19.77 (oil - $81.85/natural gas - $4.14).

It is way too high. Something has to give. Either oil prices have to come down or natural gas prices have to go up. Given the current situation, your editor expects a combination of both.

If history and basic physics are any indication, the ratio is about to head much lower in the next few months. And the gains to be had, relative to the risk, are phenomenal.

For example, if the ratio falls to the top of its long-run range of 12-to-1 you could make 64%. If it falls to the 9-to-1, you could more than double your money.

Market Neutrality: The Best of Both Worlds

The trade is a relatively simple one. You would start by shorting oil (betting it will go down) and buying natural gas. With the popularity of ETFs like the United States Oil Fund (NYSE:USO) and United States Natural Gas Fund (NYSE:UNG), it’s easier than ever to get in on trades like this.

The trade doesn’t tie up that much capital either. Since you are shorting one and buying another with the proceeds, a trader would only need to put up a small margin requirement (the actual margin requirement depends on the broker although there are regulatory minimums). That’s where the bigger gains from without having to tie up to much capital.

It’s a market neutral trade. It’s unaffected by the overall markets. That’s where the safety comes in.

Oil prices could go up or down.

Natural gas prices could go up or down.

At this point, anyone could make a case for either commodity going in any direction.

Natural gas stockpiles are high and prices could go down. Oil prices have defied gravity up to this point too. The fundamentals don’t justify $80 a barrel, it’s too early to tell if oil prices have topped-out for a while.

The oil/natural gas ratio is not predictive of which ones price will move and which way it will move.

That’s where the beauty of this trade. It’s a hedge based on the simple principle that the relationship will revert to the mean as it has every other time.

A Big Job Needs a Big Toolbox

Now, I realize most investors are hesitant to “short” anything or get into a genuine market neutral hedge trade.

But the thing is, despite our consistent unwillingness to bet against this rally, we at the Prosperity Dispatch are not going to forget history will eventually view the current rally as one of the greatest bear market rallies in history.

As a result, now is the time to start getting familiar with all the available strategies to protect and grow your wealth in a bear market.

Even though we aren’t outright bullish on stocks in general, we know as prudent investors we’ll be able to find low-risk, high-reward opportunities in lots of places.

Right now the oil and natural gas market is one of those places. The two energy commodities have become completely disconnected. But as history has shown, it never stays this far out of its historical range for long.

There are no sure things in any market. But if you think more traditional investments like stocks and bonds are overpriced and don’t offer the reward for the risk, then finding and profiting from opportunities like these would go a long way to making you a more successful investor in the short- and long-term.

Until then. Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Disclosure: Author currently holds a long position in Silvercorp Metals (SVM), physical silver, and no position in any of the other companies mentioned.

Q1 Publishing is committed to providing investors with well-researched, level-headed, no-nonsense, analysis and investment advice that will allow you to secure enduring wealth and independence.

© 2010 Copyright Q1 Publishing - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules