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Now Is The Right Time To Get Long Natural Gas

It’s no secret the past few months have been a tough ride for energy bulls.  It should have been obvious, with fracking changing the landscape, prices only had one direction to travel. I called out for lower, much lower energy prices over two years ago

OPEC’s decision to “punish” and take marketshare from others only magnified an already volatile situation and the results are in, Natural gas’s (UNG) price is below the marginal cost of production for many producers. This is causing many otherwise suppliers to reevaluate if they want to bring on and/or keep wells pumping. Some have no choice, they must keep pumping and among those, some are happy and some are truly feeling the burn.

Producers that hedged production, even at break-even from just a few months ago are currently thankful. Heck, even if they hedged a few weeks ago, or maybe days ago are thankful. But don't expect the party to last. As much as I love cheap energy prices as the next guy (After all, I do drive an Escalade that is always thirsty), and I love talking about energy prices falling, now is the time to get long natural gas.

I entered long myself, so I have my own money where my mouth is, and I added this week. It's a long I've entered and exited with frequency, but the fact remains, at least in my mind, that some of the investment vehicles could be double the price and still be a bullish bet. For example, the United States Natural Gas Fund ETF (UNG) is the one I use to gain a position in natural gas. For oil exposure, I use the United States Oil ETF (USO). It may be interesting to know that I cut my investing teeth in commodities, so I'm not averse to trading them. It's just that I don't feel the need to when ETFs are available to make it easy.

Moving back to production cost and sales prices, we know without a doubt that production cost is creating panic among producers from the falling rig counts. The rig count according to stands at 744, down another 13 from last week's count. To put it into context, the rig count stood at 1173 a year ago. That's total counts, and if we break it down into types of rigs, we largely see the same taking place with gas rigs.

We have fewer gas rigs running now then in the depths of 2009 when gasoline and oil prices fell through the floor. A year ago we had about 344 gas rigs operating in the US. The latest numbers indicate that less than 200 are producing at this time.

Obviously there's more to it then simply US rig counts, but you get the picture. The reason rig counts are falling isn't become a lack of energy available to harvest, it's because the prices have fallen to the point that those that can stop and cap wells are doing so. It's better to sit and spend the carrying cost in hopes that someday prices will rebound than to continue pumping at a loss. This clues us in on another expectation for natural gas and energy in general. Namely, that energy prices may remain volatile, but we shouldn't expect a total reversal with prices bottoming and then quickly bouncing back.

In fact, we probably for the near-term see energy prices and natural gas in particular stabilizing, and then gradually finding a new trading range that isn't far from where it's at relatively speaking. Again, using (UNG) as the investment vehicle, we should expect the price to move back into double digits, but don't expect the first digit to start with anything other than a "1".

In other words, expect UNG to trade around $10-$12 for the foreseeable future. And that leaves a very attractive investing opportunity. Especially after a day like Thursday when the S&P500 (SPY) took a nose dive.

Selling covered calls and/or naked put options makes sense for UNG because the premium is rich after the price drop, and the upside appears to have a solid lid on it. With cost of production below the market price for so many producers, we can feel confident in energy, or at least natural gas stabilizing even if not right away. That's where selling options comes into play. By selling either covered calls or puts, we are allowing our portfolio to profit from time decay. Essentially getting paid to wait it out. Because the wait will not likely result in a massive price spike, a straight long position doesn't make much sense for anyone other than active traders.

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Author Disclosure: Long UNG