Posted by Joseph Y. Calhoun, III

Bespoke has an interesting post on Natural Gas:

With oil nearing 70 and natural gas below four, the current ratio between the two commodities is now over 18. Following prior periods when the ratio went above 18, while natural gas hasn’t always rallied, it has always outperformed oil. Additionally, as we near the end of the second quarter, natural gas is entering what has historically been its best quarter of the year.  As shown in the chart below, the commodity’s average return (using the front month futures contract) during the third quarter of the year has been 12.95% with positive returns 63% of the time.

There are several ways to play natural gas. For a hedged position, one might go long natural gas and short oil to take advantage of the reversion to the mean of the ratio of the two prices. This can be accomplished with ETFs by going long UNG and short USO. Here’s a chart that shows the ratio of the two:

 

The supply/demand fundamentals for natural gas are not all that good. There have been some major new discoveries (see this story about the Haynesville Shale find in Louisiana) and there is ample inventory (22% over the 5 year average according to the Bespoke post). On the other hand, similar supply/demand fundamentals haven’t stopped oil from more than doubling over the last 6 months. One other consideration is the cap and trade bill; any move to cap carbon emissions should benefit natural gas demand.

Disclosure: Alhambra Investment Management has a small position in a natural gas ETF (GAZ).