How to Play the Lowest Natural Gas/Crude Oil Ratio on Record

One of the things we look for in the markets is anomalies or disconnects from historical tendencies that signal some element of a traditional relationship between two things is changing or has changed. Often, the relationship is eventually returned to “normal”, meaning money can be made if an investor is on the right side of the trade. Other times, the relationship has been fundamentally altered in some way, so understanding the reasons behind the shift can become a source of opportunity, since it can either provide understanding about relevant long-term trends or signal a shift in an existing one. [Such being the case let’s take a look at] the ratio between natural gas and crude oil [and determine how best to play this investment opportunity.] Words: 1069

So says Dr. Stephen Leeb (www.leeb.com) in edited excerpts from an article* which Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), has further edited ([ ]), abridged (…) and reformatted (sub-titles and bold emphases) below for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.

Who in the world is currently reading this article along with you? Click here

Leeb goes on to say, in part

Crude oil’s inexorable ascent back to… $100 per barrel has brought out all sorts of comparisons to the last time crude reached these levels, in the spring of 2008 and… it has brought the discussion back to ways that dependence on crude oil can be reduced. This got us thinking about natural gas…

Like with our silver and gold discussion this issue [see here (1)], the ratio of natural gas to crude oil is one that has traditionally been used to gauge the overbought or oversold nature of one of the two components…The ratio is now very near record levels, and will almost certainly be in uncharted territory near 30 once you read this issue. The ratio has traditionally run between 5 and 15 going back to the mid-1990s, and spikes have historically meant that the price of oil had risen too far. However, lately the relationship between the two seems to have come apart for a variety of reasons:

As you would expect, the heavily skewed nature of the ratio means one of two things can happen.

1. Either natural gas will rise in price, which is unlikely merely due to the supply overhang, or
2. crude will fall, [which is] equally unlikely, at least in the near-term future, given the geopolitical situation in the Middle East and the strategic demand from both emerging markets and the U.S.

Either way, the discrepancy highlights the fact that gas is incredibly cheap right now relative to oil. This got us thinking—where would this odd situation have the greatest impact? The short answer is not a natural gas ETF, which as a group were among the worst-performing ETFs in 2010 and are likely to remain low for the time being. Massive reserves around the world mean a large supply overhang is going to persist for some time regardless of what happens with oil, making a sustained rise in natural gas prices extremely unlikely. However, the low price of natural gas to crude oil makes Canadian oil sands extremely interesting, and thus we think a far more interesting way to play the situation is via the Guggenheim Canadian Energy Income ETF (ENY). As crude has risen, the economics of extracting oil from Canadian oil sands have vastly improved and made this avenue of production infinitely more competitive…

ENY tracks a tactical allocation between oil sands stocks and higher-yielding Canadian energy companies. The fund is designed to combine the most profitable and liquid of these companies based on the price trend of oil. In times of rising oil prices, like now, this strategy makes sense.  When prices are heading the other way, the allocation shifts to 30% oil sands and 70% Canadian energy stocks, thus providing equity upside when oil is rising and additional income security when it is not. The fund is relatively small, at $270 million, but is liquid (around 90,000 shares per day) and it currently yields 2.2%…

Oil sands extraction is extremely expensive and uses tons of natural gas in production and refining—the Athabasca oil sands deposit in Alberta alone uses over one billion cubic feet of natural gas per day – and although natural gas is abundant and relatively cheap, it is still your average oil-sands producer largest operational expense. In other words, the current record-low ratio means a profit boon to the bottom line of oil-sands producers as costs for natural gas remain low and revenue skyrockets.

*http://www.leeb.com/content/playing-ratio%E2%80%94-high-oil-and-cheap-gas

Link and Title of Article Referenced Above:

1. Silver: The Party Isn’t Over Yet

Investing is often a study of inconsistencies and contradictions. If it weren’t, the markets would be a simple game and there would no back and forth between buyers and sellers, greed and fear and technical analysts, fundamentalists and momentum players. Our experience with silver since the end of last year illustrates this [but] we [still] think it makes sense to get exposure to the metal. [Let us explain.] Words: 820

Related Articles:

1. What Happens to Oil Prices if Israel Bombs Iranian Nuclear Facilities?

We now believe that there is at least a 50% probability of Israeli airstrikes against Iranian nuclear sites… Iran has multiple retaliatory options at its disposal…[and it begs the question:] Which options would most adversely affect the price of oil? [Let’s take a look at what those options would be.] Words: 544