Is It Still Time To Buy Natural Gas?

On a twenty year history, we're looking at a 98% probability upside, while on a forty year history, we still need to see a fall of 50% more for a 90% probability upside, assuming the past will mirror the future.

Some of you may remember my post from earlier this year, Is It Time To Buy Natural Gas? Once again, natural gas is becoming cheap again so I'm keeping my eye on it. My buying interest will peak once it falls below $2.25. This year, the lowest price I recall was $1.65 and it bounced up from that price quickly, so I fully expect that another crash below $2 - if it occurs - will result in a strong bounce once the bottom is found. Let's review some of what I wrote in the past while updating some pieces:

Pros

Since I use natural gas for energy, I can create a win-win scenario for myself by purchasing a basket of natural gas companies, which if continue to fall in price because natural gas prices fall, then I'll also see lower natural gas bills in my usage. I use this strategy for offsetting "necessity costs" and I'll admit that this has been an effective tactic with many of my other necessities. While this generally works for necessities, it doesn't always mean that the purchase was an opportunity to enhance wealth.
When something becomes cheaper, the demand rises. If natural gas prices continue to fall, I fully expect the use to rise. In addition, if natural gas continues to fall, energy competitors will feel pressure because companies that use energy will have the choice between cheap natural gas and expensive [alternative].
In the last 20 years, I've observed that commodities tend to lead recessions and bubble bursts, but also tend to recover quicker than everything else. What this means to me is that when natural gas hits its bottom - wherever that is - it's bounce up will be fast and furious.
If companies become more cost efficient at obtaining natural gas, while that may lower the price, the companies will become more profitable. If companies can't get natural gas in a manner that is cost efficient, they'll go bankrupt in the long run or will be very clear losers in their balance sheet. This is another way of saying, "If they don't do good, then they'll fail, but if they do good, they'll make more money." Translation: I win.
On a long enough time scale, the risk of doing nothing exceeds the risk of doing something.
Commercial hedgers appear to take an extremely bullish position in natural gas around $2 or less. These guys are smart because they're buying at the right time. So far, I've been impressed. In general, my view of commercial hedgers is that they tend to be wrong - however, natural gas is an area where they've been right.
In the last 20 years, natural gas has stayed above $2.50 90% of the time. Slightly over 50% of the time, natural gas has stayed above $4, based on my chart analysis. Natural gas is currently $2.60.

Cons

I never underestimate just how bearish most people can become with something, even if the cost to produce the something is higher than the profits from selling it, meaning that a day of reckoning is about to happen (ie: when companies fail because they're losing too much money). When people warn about "don't catch falling knives" this is what they mean - the price of natural gas may go as low as $1 before it's over with, even if in ten years, natural gas is back above $5. The reason this happens is because feckless companies borrow too much money and must continue to pay their debt - if they had avoided debt, they wouldn't need to sell their resources at a loss.
Some companies are avoiding the sensible thing: cut your dividends to $0, pay off all your debt, lay off all your workers, idle all your wells, and completely cut off the supply. If several large companies did that, the price of natural gas would soar within a month and the company could rehire the workers it laid off and begin making a profit again. The reason companies don't do this is because they're heavily in debt and fear losing investors, which "dividend-slashing" tends to do. This tells me that the bottom is probably not in yet, because when companies finally begin doing this, that's the end.
According to my analysis, natural gas is at a 84% 20 year discount; it still has further to fall before it hits a 90-95% 20 year discount. This isn't to write that it will hit a 90% discount, just that it hasn't yet.
I have to be careful about natural gas basket ETFs, as these tend to throw in the towel right at the bottom. Some American investors don't grasp what they're doing and ETFs must follow what's popular in order to make money. Unfortunately this is a risk because it means that by the time an investment has recovered, ETFs show up to the party late. However, ETFs closing down for an industry can be a signal that it's time to buy.
What am I missing? What am I not looking at? I have to ask myself this to remind myself that I don't know all the variables and need to learn more about the industry and the industries that relate to it, since I've done my due diligence on the price and balance sheet of companies. This is a con because until I do this, I would be completely irresponsible for buying anything in this industry thinking that the bottom has arrived.
Since I enjoy messing around with probable scenarios, one of them strongly indicates that natural gas will break $2, meaning that it might fall even further. This is more of a concern for a non-hedge move. The hedge move is done, relative to price point history, while the opportunity move is not in yet and may not be in for a while.

What I'm Watching

Sinopec. I already own a lot of shares at a great price and this company has paid solid dividends for the last fifteen years. Nothing would make me happier than it slashing all its dividends, paying off all its debt, and eliminating all the oil and natural gas supplies since this is the largest oil and natural gas company in the world. I nailed Sinopec perfectly, and it's much higher than its low, so this one is on hold for the time being.

Physical natural gas wells. Very high risk and very profitable. The key with these is to wait out the bust.

FCG. This is an ETF natural gas basket which was hovering at its lowest price. Since ETFs have a tendency of closing when the bottom is in - like many Russian ETFs closed when Russia was at its lowest - this one was a risk because it may have closed and forced a loss. For the time being, it hasn't closed. Still, be careful! ETFs are notorious for doing the wrong thing - buying into hype and only offering securities when they're popular. Anyone with a brain should be pushing natural gas because it's so cheap, yet few are.

FCX. I own quite a few shares of Freeport-McMoRan, but I'm not bullish with them because of natural gas or oil, as they've made major goofs with both. I like them from the mining angle. Still, I am keeping an eye out for who they sell their natural gas and oil to, so they are a useful signal on that front.

Russian stocks. How many morons on Wall Street told me that I would be wrong about Russia and yet here I am with a better return on my shares than their lousy S&P 500 return? I won big with these and continue to win big. Once again, I beat Wall Street.

Juniors and Mid-Level Companies. These carry huge risks, but if they survive - and many won't - they'll be the big payoff.

The US Dollar. Natural gas is falling while the US Dollar is also falling. This is peculiar and reinforces my view that natural gas is moving in the direction of possibly becoming a good buy. When I look at natural gas right now it's $2.60, so it still needs to fall some more before I buy again. However, the US Dollar is headed one direction in the long run: down.

Precious Metals. I like precious metals and a few of them are moving in a favorable buying direction; if both natural gas and precious metals fall equally, my purchases might be split. Note that I only buy the cheap ones.

Conclusion

Here's what I really love about natural gas: in my view, I'll have quite a few opportunities to become a buyer again and like real markets, it's experiencing some rises and falls. Healthy markets rise and fall and corrective cycles are absolutely needed. Amazingly, many of the investments I made are doing very well - for instance, Chesapeake Energy as an example bounced off about $1 a share very strongly and Sinopec bounced hard too.

Just to update readers on my natural gas trades: almost all of them have beat the S&P 500 at this point. I can only think of one that has performed poorly, but being a junior producer, I'm not surprised.

Note: some of our posts appear on our blog FinTekNeeks.