The secret to good equity analysis (as taught to me when I was a cub analyst at DLJ more than 20 years ago) can be summed up in one word: "disaggregation." You figure out the contributing factors in any asset's price, which allows you to forecast its future price. Divining a different value than what the market is currently giving an asset can make you a profit -- something I see as possible right now with natural gas.
You might not be sufficiently familiar with energy markets to know that the front-month natgas contract is trading at around $2.75 per 1 million BTUs. But a simple look at a chart would show you that the January 2018 contract (which is now the next to expire) was trading as high as $3.30 per mmBTU in October and above $3 per mmBTU as recently as last week.
Even for a futures contract that's earned the name "The Widowmaker" among energy traders, that kind of drop in one week is a big deal. Is this a buying opportunity?
Well, the first data point to check when dealing with any commodity's price is inventories. A quick look at EIA.gov shows that U.S stocks of natural gas were 3.626 billion cubic feet as of last week's end. That's 5.3% below levels the same week last year and 0.7% below the five-year average. The EIA's Web site also has a very informative chart that demonstrates that natgas inventories are just where they should be entering the U.S. heating season.
So, we've found a disconnect -- falling prices despite lower inventories. The only explanation for this week's plunge is a perception among traders that fundamentals are going to weaken.
Let's check it out:
You Don't Need a Weatherman to Know Which Way the Wind Blows
Go to a respected industry source such as Natural Gas Intelligence and it presents analysis like this:
We're getting the cold weather now, finally ... but the problem is the weather models are not holding onto it," Commodity Weather Group President Matt Rogers told NGI. "There's just so much volatility."
In the back half of the six- to 10-day and first part of the 11-15 day, Rogers said the latest guidance showed a "temporary breakdown of the pattern's structure that would allow more warmth to move across the country."
-- NatGas Futures Test Low End Amid Volatile Weather Outlook, Rare December Storage Build, Natural Gas Intelligence, Dec. 7, 2017
Was that helpful? Not to me. Unfortunately, my experience has shown me that the weather-forecasting services used by trading houses are no more reliable than the person on your local news standing in front of the green screen and pointing at the cold front.
My advice: Don't ignore the weather around you. My New York City apartment has a great indicator of current temperature -- a very noisy radiator. For the past few days, it's been cacophonous, and that tells me all I need to know about the weather in America's largest metro area.
Check the Stocks
The next thing to look at is how natgas firms are faring in the stock market.
There are five natural-gas stocks that I follow -- Antero Resources (AR) , Chesapeake Energy (CHK) , Eclipse Resources (ECR) , Range Resources (RRC) and Southwestern Energy (SWN) . Here's their one-month performance through Friday's close, with the S&P 500 included as a reference. Although natgas stocks are rebounding some 3% Monday, all I can say is, "Ouch!":
The Bottom Line
If you believe in mean reversion -- and in the old advice to "buy low and sell high" -- it's worth investing in natgas plays right now.
That's not simply because the stocks are down, but because they're falling in a period of improving fundamentals. That's an investable set-up.
I don't own any natgas names today, but I'll be doing the research on them over the weekend -- thanks to a hot tip from my noisy radiator.
