ATLANTA -- We continue to view the natural gas market as strongly imbalanced to the downside with a correcting reversal growing more, not less likely. Having said that, since our paper profits have become material in the royalty trusts, it’s time to ratchet up protective stops so that we do not lose that trading discipline (or lose most of our hard-won gains). 

As we like to put it, we do not want to anger the Trading Gods by giving back the fruits they have given us. 

Please note: Gold Newsletter (GNL) subscribers received this special issue of the Got Gold Report Monday morning, August 31. GNL subscribers enjoy access to all Got Gold Reports, technical charts, analysis and information, as well as Brien Lundin’s timely and actionable analysis of specific resource related companies. For more information or to subscribe visit the Gold Newsletter home page. 

“Gensler’s Raiders” 

Those playing the downside of natural gas futures have had a terrific summer thanks to an unnatural assist from U.S. regulators at the Commodities Futures Trading Commission (CFTC), whose actions have exacerbated an already imbalanced market. Indeed, it was that political and regulatory interference in the energy markets that convinced us to roll out of an energy ETF and into royalty trusts with the August 5 update. 

We believe that the damage done by the CFTC is already largely factored into the current Nat Gas pricing. The market apparently agrees with that assessment as we continue to see signs that the market is pricing in higher, not lower natural gas in the not-too-distant future. We will look at several of those signs in a moment, but with this update we also remind our short-term trading friends to use effective trading discipline with even the royalty trusts (in the last section of the report). 

Natural Gas is a longer-term play for us. As a practical matter we are still in the accumulation stage of the trade – ahead of any material change or reversal in the price of the commodity – but confident that eventually a material and probably historic reversal is inevitable. With overly-wide contangoes in the futures markets and the energy ETFs under attack by the CFTC, we settled on the natural-gas heavy royalty trusts to take the point of our Nat Gas positioning. The small monthly distributions they throw off are an extra bonus that we hope will offset the lack of upside volatility once the reversal gets underway in earnest. 

For this interim update, first let’s look at ratios to see if our valuation imbalance for natural gas is still in play (of course it is, but by how much?). 

First up, since the last full update, Nat Gas producers held their collective ground while the September (now expired) and October Nat Gas contracts were clobbered by continued high natural gas inventories, very mild summer weather and assisted by CFTC-caused confusion and chaos (more about that in a moment).  

The natural gas producers in 30-minute increments over the last 20 trading days:  

The result is an amazingly wide divergence, which is screaming that Nat Gas has overshot to the downside in historic proportions.  (The ratio below compares the AMEX Nat Gas Producers Index with the price of the front month NG contract. When rising, the producers are outperforming natural gas and vice versa.) 

No one has ever seen such an extreme divergence in this ratio. One takeaway from the ratio is that money managers have already invested in natural gas producers in anticipation of a reversal in prices. As usual, the market anticipates price action in advance.  Sometimes well in advance. The producers are also helped by much stronger oil prices. All of the extreme divergence cannot be explained by higher natural gas price expectations, but neither can all of the current amazing divergence be explained solely on the basis of the oil price. 

Gauging an imbalance in the markets using just one measuring stick is like a doctor treating a patient on the basis of just one symptom. It might be the right treatment, but it is probably better if the doctor considers more symptoms.   We can see that the Nat Gas producers are wildly outperforming natural gas itself with one look at the ratio above, but is natural gas really at an extremely low price relative to other markets?   It is an important question to answer if we are truly concerned with taking a longer-term position to take advantage of an imbalanced market.  

Is natural gas really cheap?    

Again, if our job is to take advantage of a price imbalance (and get paid for it), we first have to establish that there is a true imbalance. There are loads of contradictory analysts out there with lots of conflicting statements as each sells his or her preference in the markets based on his/her differing time horizons. If we rely on them for guidance it just breeds confusion or indecision. Instead, to establish whether or not an imbalance exists, why don’t we look at some longer-term value comparisons? Below are a few such comparisons. 

In terms of gold, the only real money for free men, Nat Gas is certainly extremely cheap right now.  

Obviously natural gas is extremely cheap relative to gold historically speaking. But is gold too expensive, or is Nat Gas too cheap? We are inclined more toward the latter than the former. Like the $XNG: $Nat Gas chart, the $Gold: $Nat Gas ratio above has also become an extreme divergence, worthy of our interest, but as of right this minute (Sunday afternoon) we would not be comfortable selling this ratio just yet because that would mean selling gold. A more likely ratio to be sold would be the oil/Nat Gas ratio just below:  

Long-time traders view this particular chart and usually make a profound comment, such as “wow!” It is further evidence of a natural gas price imbalance. We are all witness to one of the most extreme value divergences in history. Currently, with the October Nat Gas contract at near $3.01 per MMBtu, that is the equivalent of roughly $17.46 oil using the EIA’s conversion factor of 5.8:1. Oil closed at $72.86 or so Friday, August 28, so in terms of oil, natural gas is a screaming bargain at today’s prices. 

Which is cheaper to use? Currently $17.46 per barrel-equivalent natural gas or $72.86 West Texas Intermediate Crude?  (Points deducted if you had to think about that one.)  

By the way, be wary of the majors in oil that have a large Nat Gas component, the ones that use bbl-oil equivalents for Nat Gas, because they could be forced to restate their reserves if there is not a reversal in Nat Gas (before the end of September).  

So far we have looked at natural gas relative to the Nat Gas producers, gold and oil, and in each case natural gas is near or at record price divergences, but how about other valuation metrics? 

Well, how about silver for comparison? 

Nat Gas is historically cheap in the extreme relative to silver too.  

How about copper?  

Yes, natural gas is cheap in historic fashion relative to copper.  

We could go on and on with more comparisons, but the point is already made. Natural gas has become unbalanced to the downside measured just about any way one wants to measure it, including in “dollars and sense.” We are interested in all these valuations because we firmly believe that the market abhors imbalances. The market tends to correct them over time, nearly every time. We can participate in the inevitable corrections of market imbalances if only we have the courage of our convictions, the means and the vehicles to play them with. 

Speaking of vehicles, are we glad that with the August 5 update we moved out of the natural gas ETF UNG and into natural gas-related royalty trusts like San Juan Basin Royalty Trust (NYSE: SJT) and Permian Basin Royalty Trust (NYSE: PBT)? You bet! Since then UNG has faltered badly even though at its closing price Friday of $11.13 it now trades at an unseemly premium of over 19% to its $9.35 net asset value (as of August 28). 

Compare the woeful action of UNG just below to the two royalty trusts mentioned (there are others equally as worthy of our interest). 

UNG in half-hour terms for the last 20 trading days: (In a word, ugly.)  

Compare to San Juan Basin Royalty Trust for the same period: 

Compare to Permian Basin Royalty Trust for the same period: 

Are we worried that there is more weakness to come in Nat Gas?  Sure, it is already beyond ridiculous in the Nat Gas futures market thanks to the CFTC’s attack on investors and the disruptions caused by the energy commodity funds having to downsize their futures positions.

The Commodities Futures Trading Commission (CFTC) is now punishing the “investor class” by reneging (and threatening to renege) on the exemptions from position limits it granted to Nat Gas exchange traded funds, like the United States Natural Gas Fund (NYSE: UNG). The CFTC-caused confusion in the natural gas markets has given the “Big Gas Bears” an early Christmas present as UNG and other ETFs felt they had to quickly downsize their positioning in the Nat Gas futures markets. 

Bearish interests in natural gas knew, as we all did, that Nat Gas ETFs were under the CFTC gun and had to reduce their futures positions. So what did the “Big Gas Bears” do? Why, of course they naturally pressed their CFTC-assisted advantage as any respectable hyena would. (They might have even considered sending Chairman Gensler a fine bottle of his favorite spirits in gratitude!)  

As another practical matter, no matter how much the CFTC meddles with the markets now, the result will be that much more violent of a reversal once it arrives. Once the bears understand it will no longer be “fun” to be bearish, they will become buyers again.  

All “interventions” into commodities markets are temporary

However, we have to fear that the CFTC is not done yet. Having found they can manipulate the price of Nat Gas and wheat short-term lower by yanking exemptions from UNG, GAZ, DBA, DBC, et al, - in effect rendering them unable to perform their stated missions – in effect rendering them down to the futures position limits of a single trader rather than an aggregator of many traders - all while preserving the hedger’s and commercial’s ability to ignore the same limits, allowing the short side to  crush the markets in the ETF fund’s retreat – we’d all better hope “Gensler’s Raiders” don’t try to figure a way to run a similar attack on precious metals.  

Luckily, most of the precious metals ETFs don’t use futures at all. They store the physical metal instead. The only concentrated positions in precious metals futures are all on the commercial or financial hedging short side – the side dominated by a couple of large U.S. bullion banks; the side that the CFTC seems so far to enjoy protecting. 

It is this inconsistent stance that has traders crying foul. As the CFTC threatened to renege on energy ETF aggregators on the long side there were absolutely no corresponding actions against the short side of the market. “It just looks like attempted price control,” is a frequent comment on trader blogs.  

It is amazing that more analysts and commentators are not all over this developing CFTC reneging-on-exemptions-for-ETFs “scandal.” Whether intentionally or otherwise, the CFTC is seen working for the hedgers, the commercial shorts, and against investors in commodities – pure and simple. They have not once mentioned limiting positions for the short side of any market. Not once!  

All their actions and nearly all their comments are to the contrary. Judging by CFTC actions so far, anyone who thinks that the CFTC will limit the short side of any market is just dreaming or hoping. Does anyone really believe that anyone at the CFTC, now run by a former Goldman man, is going to muck up Goldman Sachs’ and JP Morgan’s playground? 

Whatever; we can’t make money from these CFTC-run-amok musings, but we certainly can attempt to take full advantage of them once the damage has been done. 

Moving on: This past Thursday the Energy Information Administration (EIA) announced an implied natural gas injection into storage of 54 billion cubic feet (54bcf), near the low end of analyst’s expectations, but well under the 15-year average for that reporting week of 63bcf. As we have already noted in previous reports, this is during one of the mildest summers in the eastern U.S. in 50 years, so seeing an injection of 54bcf now is not remarkable. What is remarkable is that it was “only” 54bcf. 

If Nat Gas was really as over-supplied as the Big Gas Bears say it is, the injection should have been much higher under the circumstances.   

Finally, is it really only five weeks to October? Notice, please, that the Stockcharts graph below has already moved to the October contract. The fireworks in the September contract, with one of the best CFTC bear-assists in anyone’s memory …   is history.   

Head for the Big Easy  

Before moving into the conclusion section just a quick note to say I’m looking forward to presenting and meeting some of you at the always exciting and stimulating New Orleans Investment Conference to be held this year at the Hilton New Orleans Riverside October 8-11.  

The New Orleans conference has always boasted an impressive speaker lineup, but this year conference organizer Brien Lundin has outdone even himself with a power-packed menu of experts and savvy intellectuals in both business and politics.  Including Dr. Marc Faber...Dennis Gartman...Peter Schiff...Dr. Stephen Leeb...Doug Casey...Rick Rule...Adrian Day...Frank Holmes...Bob Hoye...Bob Prechter...Dr. Mark Skousen...Ian McAvity...Pam and Mary Anne Aden...Brent Cook...David Coffin...Lawrence Roulston…Thom Calandra…Rick Santelli…Carl Rove…Howard Dean…Charles Krauthammer and many, many more. 

For more information or to reserve for the conference please use this special link and send me an email note if you plan to attend so we can connect there.  It should be fun, interesting, entertaining and very worthwhile. 

Summing up: While some analysts have confused what the CFTC has said publicly to fit their own desires for the futures markets, the fact is that up to now the only actions taken or threatened by the CFTC deal with position limits for the long side, while saying they intend to preserve exemptions for the hedging or short side. As if people who engage in financially settled hedging could not possibly be “speculators.” 

As I said in my energy hearings comment letter, if the CFTC were concerned about “fairness” they would apply position limits equally and fairly on both sides of the battlefield, long and short. They would not allow any entity, including financial hedgers, to amass overly large, concentrated positions. Instead the CFTC, under Gary Gensler, believes that all of us who might buy a few shares of an energy ETF are evil “speculators” with no “economic reason” to be in the markets for oil and Nat Gas.  

This power-hungry CFTC makes our job more difficult and it makes the energy markets even more uncertain than usual for now. There will be hell to pay in these markets in the form of huge, unintended consequences as a result of the liquidity that Mr. Gensler and company has just intentionally removed from them. Every American will end up paying for it in the long run as producers are forced to shutter production, contracts are thrown into default and companies are destroyed by the currently artificial low prices. 

However, it is exactly those artificially low prices that give us such a unique opportunity right now.  

What that means to us is an enhanced, CFTC-assisted opportunity to participate in one of the great market imbalances and eventual corrections of this generation. We certainly plan on doing just that.  

However, with sizable gains in our royalty trust positions and no confirming strength yet in natural gas itself; with the CFTC on the warpath against energy ETFs and likely more news to surface shortly there, it is time for trading discipline and money management to rule. 

While each trader has to study the issues carefully and make his/her own decisions, we plan on moving our trading stops for our royalty trust positions up to “near resistance” levels Monday to protect hard-won profits. 

Should the royalty trusts correct back lower, we plan to add to our positioning in incremental units once we are convinced that the correction has exhausted itself. We are about to transition from the worst part of the annual cycle for natural gas to the best part in the span of three months, so stay sharp out there. 

With the hatches firmly battened and the sea anchor out, perhaps this particular Nat Gas price storm is nearing its peak.  While the short-term disruption in the futures market has created “extremely extreme extremes” in prices, the fact is that Nat Gas has over-shot to the downside … for now. 

Oh yes, lest we forget, the natural-gas-bearish story was all over financial televised media this past week. By the time that happens, whatever the trend, we know the odds are that it’s nearly over. 

That’s it from Atlanta this week. Hope to see you in New Orleans in October. 

Until then, as always, MIND YOUR STOPS! 

Related Charts:  

·         San Juan Basin Royalty Trust

·         Permian Basin Royalty Trust

·         United States Natural Gas Fund

The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure: The author and/or his family currently holds a net long position in SPDR Gold Shares, net long iShares Silver Trust, long San Juan Basin Royalty Trust (SJT), long Permian Basin Royalty Trust (PBT), long the following “Vulture Bargain Hunter Stocks” mentioned in this report or within the last three months: Timberline Resources (TLR), Paragon Minerals (PGR.V), Forum Uranium (FDC.V), Odyssey Resources (ODX.V), Radius Gold (RDU.V), Columbus Gold (CGT.V), Endeavour Financial (EDV.T), Terraco Gold (TEN.V), Hathor Uranium (HAT.V),  Natcore (NXT.V), long SDS as a Big Market hedge and currently holds various (approximately 25) other long and short positions in mining and exploration companies. The author receives no compensation from any company mentioned in this report. To contact Gene use LLCCMAN (at) AOL (dotcom).