Pipe In Some Natural Gas

 | Dec 22, 2011 | 11:00 AM EST  | Comments
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FCG

This commentary originally appeared Dec. 22 at 8:30 a.m. EST on ETF Profits -- to access all the strategies from our team of ETF professionals, click here.

For many investors, the holiday season is anything but relaxing: This time of the year means tinkering with portfolios, positioning them to profit from trends expected in the coming months. Of course, the current environment is also quite challenging. Though the U.S. economy is certainly showing signs of life, a lot could go wrong in the not-so-distant future, making asset allocation a tricky task for investors of all levels of risk tolerance and degrees of sophistication.

Despite the challenges, there are a number of compelling opportunities for 2012 -- and, over the next several days, I'll be laying out a handful of actionable ETF investment ideas that appear set to generate meaningful gains in the new year. I'm starting with a dive into a corner of the global energy sector that is often overlooked, but is slowly becoming a major force likely to account for a big portion of energy supply in decades ahead: natural gas.

It had long been presumed that alternative-energy sources such as solar and wind power would gradually replace our need for oil, with a "green energy revolution" pushing out fossil fuels and ushering in an era of energy independence. As we've seen, though, solar and wind power have struggled to find economic viability in a challenging fiscal environment, with many companies going bankrupt in recent years. There have been some successes, of course, and the market share of alternative-energy sources has increased dramatically. But hope is dwindling that these clean-energy sources will replace fossil fuels.

As such, I have at least one thing in common with energy magnate T. Boone Pickens: We're both incredibly bullish on the potential for natural gas as part of the solution to the U.S.'s long-term energy problem. The fuel has seen a groundswell of support, and the case for utilizing more of it is relatively easy to make: It's clean, it's cheap, and it's abundant within U.S. borders. Perhaps most important, extracting and selling natural gas has already been demonstrated to be profitable, meaning it has the potential to be scaled up dramatically in coming years.

That's a tough combination to beat. With oil prices pushing $100 per barrel and fairly regular massive discoveries of new natural gas reserves, it seems logical to conclude that this fuel will account for an increasingly larger portion of global energy demand going forward.

The recent setbacks in nuclear power, which has become politically dangerous in the wake of the Japan disaster, have further opened the door for alternative power sources to gain ground. There are, of course, some hurdles. A meaningful threat to the industry, for instance, lies in the lingering debate over the potentially adverse environmental impact of extracting natural gas.

Many investors looking to bet on natural gas have embraced futures-based strategies designed to offer exposure to the price of the actual commodity. But that's a flawed approach for many reasons. First, natural gas prices have been steadily sliding for years as a result of massive increases in supply. New discoveries of previously unknown reserves have been made around the world, and there's no reason to suspect that will slow down any time soon. Second, even if prices were to jump amid climbing demand, the nuances of futures-based strategies could create stiff headwinds that may be difficult to overcome.

The First Trust ISE Revere Natural Gas Index Fund (FCG) represents a more effective strategy to betting on a natural gas boom. The fund consists of companies that derive a substantial portion of their revenue from the exploration and production of natural gas. In other words, these firms will be taking in money from the future sale of natural gas.

The ETF's methodology is compelling, as well -- potential components are screened by factors such as price-to-earnings ratio and return on equity, and the portfolio spreads around exposure to make sure no one name dominates performance (no single stock accounts for more than around 4% of assets). FCG is the only ETF currently available to U.S. investors that focuses exclusively on natural gas stocks, but it's really all we need -- thanks to this fund, there's a way for all types of investors to get in on what seems to be a very promising opportunity.

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