Sell Oil, Buy Natural Gas

04/30/2009 11:00 am EST

Focus: ETFS

Jack Adamo

Editor, Jack Adamo's Insiders Plus

Jack Adamo, editor of Jack Adamo’s Insiders Plus, says oil prices are heading lower, but natural gas is poised to rebound.

I think the market is heading south for the summer, and I want to take advantage of it. We are already about two-thirds in cash in the main portfolio and about half cash in the income portfolio. These recommendations are based on my belief that it will be hard to make money in the market for the next few years, and taking some risks may be expedient.

Our new long position is in natural gas. It may be a bit early, but I plan to accumulate a position over the next few months. Natural gas is at lows it hasn’t seen in many years. Spot natural gas at Henry Hub was going for $3.56/mcf [last week]. The historical average price for the last five years is around $7, and it was $13 as recently as July.

At its current price, it’s selling at less than its average finding cost; so producers are shutting in capacity. That will eventually cause a rebound in prices. I expect them to make a nice move by December and be back in the $7 range within three years. We’ll use the United States Natural Gas Fund ETF (NYSE: UNG). It seeks to duplicate one for one the performance of natural gas prices in America by buying futures contracts.

It’s a small ETF—it has under a billion dollars in assets, so I’d use limit orders when buying, rather than market orders, at least for now. I have a feeling its assets will be much higher by year end. Buy US Natural Gas Fund ETF up to $15. (It closed at $13 Wednesday—Editor.)

PowerShares DB Crude Oil Double Short ETN (NYSE: DTO) seeks to achieve double the inverse movement of the oil price. The shares will rise if crude oil falls and should do so at approximately twice the velocity.

If it seems odd that I’m recommending shorting oil while buying the natural gas exchange traded fund, that’s because natural gas has plunged for months, and I believe it has very manageable downside risk from here, and plenty of up side in the next several years, as I’ve outlined already.

On the other hand, I think the strength in the economy touted by Wall Street recently is bogus, and that will show up in the price of oil shortly. I expect West Texas Intermediate crude to fall into the 30s, despite summer driving season. If I’m wrong, we can pull out of this relatively quickly.  Buy the PowerShares DB Crude Oil Double Short ETN up to $200. (The shares closed below $175 Wednesday. Double-short ETFs are only for risk-tolerant investors who can afford to lose the money they’re investing—Editor.)

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