The "Secret"—and More Profitable—Sector of Natural Gas Stocks

This is what I call the "shopping season” for natural gas stocks. And even though I'm a longer-term bear on natural gas, there is one part of the natural gas market that is not well known, I think mis-understood, and potentially mis-priced. As a result, I think it could make me money this year—and I think now is the time for me to be buying this little subset.

The reason for these purchases NOW is that every year, summer is the weakest time of the year for natural gas and sets up an annual trade for natural gas stocks—buy in June-August, sell in December-January when North American heating demand should have natural gas trading at its year highs.

Last year gas stocks languished badly through the summer, forcing fire sales on assets and it took every bit of goodwill the bankers and producers (in Canada) had for each other for some of these companies not to go bankrupt. But September 2009 saw a large seasonal jump in natural gas prices—they roughly doubled from $2.50/mmcf to $5 in January 2010—despite fundamentals remaining poor. And there was a great 4 month trading rally.

However, natural gas prices in the US and Canada actually turned up last week, enough to get the market excited. I see that the market wants this trade to work so desperately. I am not bullish intermediate or even long term on natural gas, so I expect that if there is a rally in gas, it will just be a traders rally. But like I said, last year gave investors a fantastic seasonal rally in natural gas stocks—as long as you sold in January, the seasonal high.

As a trader, natural gas does have some positive things going for it besides seasonality:

1. Technically, it had a minor breakout this week. The 28 week moving average for natural gas this week was $4.52. This is just my sense but as the price neared that level, more speculative fever came into the market that it would break through this level, and when it did, natural gas got a pop. And the Canadian market followed suit in sympathy.
2. The market is clearly willing to bid natural gas up on weekly injections that are only a bit smaller than last year.
3. It's possible that at some point in the coming weeks the cumulative amount of gas going into storage will slip below last year, and the market could take that as a bullish point to move up the gas price. US gas is only about 2% above last year's storage levels at this time. (See chart below).
4. And US gas prices will certainly get an emotional boost whenever the first hurricane is named.
5. Coal prices are trending higher, making natural gas more competitive in some areas.
6. US gas demand is up year over year and crude inventories are declining.
7. The blowout of a US gas rig in Marcellus shale could bring in new drilling regulations-increasing the cost and time to get wells into production.

So I'm going to establish some small starter positions in producers in one particular subsector of the natural gas market—that is potentially mispriced by the market. All boe (barrels of oil equivalent) are not created equal.

Now, as usual with the stocks in my portfolio, these companies also have large undeveloped land packages, and are low cost producers. I'm not making any big bets yet, but subscribers will see where I'm going and can decide their own comfort level and timing.

In my next article, I'm going to tell you what this little known sector is, and why these particular natural gas companies are so much more profitable than their peers.;