2 Plays to Get Your Fill of Natural Gas

02/07/2012 8:30 am EST

Focus: STOCKS

Natural gas has become a very promising commodity, and the market has been trying to price in the potential and the reality, writes Jason Cimpl of TradeMaster Daily Stock Alerts.

The market had a fairly boring session last Thursday. Banks continued to provide the usual leadership, which is bullish. And the financial index finished 0.49% higher in an otherwise mundane day.

Yet unlike the broad market, natural gas had a wild session. Over the past month, the price of natural gas has both risen 25% and fallen 33%.

Commodities are volatile by their very nature. Not only is the price controlled by the ebb and flow of supply and demand, but it’s also subject to regulatory changes, natural disaster…and in some instances, acts of sabotage.

In the case of natural gas, it fortunately came down to old school economics: supply and demand. The US continues to focus on foreign crude oil and coal for energy production. And demand for energy alternatives like natural gas hasn’t increased.

The lack of demand was also accompanied by an increase in supply, which was a double whammy on the price, and the main reason why natural gas prices are near lows not seen in the commodity futures market since 2002.

The increase in supply was directly tied to major gas discoveries in the Barnett Shale, Bakken Shale, and Marcellus Shale formations. New techniques have also increased natural gas drilling efficiency.

With zero demand growth and increased supply, the price of natural gas has had nowhere else to go but down. But last week, that changed.

An inventory report showed that natural gas had a bigger-than-expected January drawdown despite rising production and warm weather across America this winter. The drop in natural gas inventory followed reports last month that producers like Chesapeake Energy (CHK) would halt drilling because prices had dropped to unprofitable levels.

Natural gas has collapsed for the past four years and has been on a gradual decline for almost a decade. Prices topped near $16 in 2005 and came back to $13.46 in 2008. But since that high, natural gas has declined 85% to $2.25 in 2012.

While I can’t say for certain that the move in natural gas over the near term represents a massive bottom, I do think prices will rise over the next few months. Given my bullish stance, we went long the United States Natural Gas Fund (UNG) in my daily stock service last week, and I will hold that ETF until such a time when I believe natural gas did not bottom.

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