Commodity Trading Strategies: Profiting from Gold and Natural Gas

Sam Subramanian PhD, MBA

Investors often lump commodities together and run the risk of making improper investment choices. While some commodities can be hot, others may not. The supply and demand factors affecting commodity prices are usually specific to a commodity.

Take the case of gold and natural gas this year. The price of gold has been relatively strong. The surge in the yellow metal's price over the past few trading sessions has put gold just short of the $1,000 an ounce mark, the third time gold has approached this level.

In contrast, the price of natural gas has been on a downtrend. With a series of lower lows getting set, natural gas prices are near levels seen in March 2002. To some, such weakness in natural gas has surprisingly come in the face of strong oil prices.

So what gives? What's driving gold and natural gas?

Gold - Demand and Supply

Following a spectacular 52% advance in the S&P 500 from its March 6 lows, investor's comfort with equities has eroded on concerns that stock prices are leapfrogging an eventual economic recovery. The implications of soaring budget deficits in the U. S. and U. K. are a point of concern as well.

Divergence of gold and natural gas prices indicates the need for commodity trading strategies.

Against this backdrop, investors appear under-weighted in gold. They are pulling monies out of equities to put them in gold. Meanwhile, central banks are restraining their sales of gold and limiting supplies of the precious metal. The European Central Bank, the Swiss National Bank, and Sweden's Riksbank have agreed to limit gold sales to less than 400 metric tons per year over the next five years.

Natural Gas - Demand and Supply

First off, it is important to note that unlike oil, natural gas is a domestic commodity. The price of U. S. natural gas is influenced primarily by U. S. demand and supply. Economic growth in regions like China and India has little bearing on natural gas. In contrast, the price of oil is influenced by growth in Asia.

The deep U. S. recession has taken a heavy toll on natural gas demand. The U. S. Department of Energy expects use of natural gas in U. S. factories to decline 8.6% this year. Steps taken by gas producers in curtailing output have not been adequate in stemming the surge in natural gas inventories. According to the Energy Department, natural gas inventories have bulged to 3.323 trillion cubic feet, a seasonally adjusted high since 1993.

So, what's the right way to play gold and natural gas?

Profiting from Gold

Given the strong run-up in the price of gold and gold-related assets last week, a short pause may be in order here. That said, the fundamentals for gold appear reasonably favorable at least in the near-term. From a technical perspective, the momentum is with the bulls. The seasonal pattern too favors gold. Coming just ahead of the surge in jewelry demand from the wedding season in India, September is often a strong month for gold.

It is conceivable that gold can crack the $1,000 an ounce mark in the near future and stay above this psychologically important level. Where gold goes in the intermediate to long-term depends on the ability of the U. S. dollar to hold up against major world currencies. Gold can thrive if the greenback declines and inflation heats up.

Read: Specific ways to invest in gold

Investing in Natural Gas

The near-term supply-demand balance for natural gas looks pretty depressing. The market is well-supplied... to put it in mild terms. Barring a surprise wave of warm weather that increases air-conditioning demand or a storm that reduces Gulf of Mexico natural gas output, excess inventories are likely to keep natural gas prices in check for sometime.

Natural gas investments are a longer-term play premised on the belief that the U. S. economy will resume growth sometime in the future. The attraction is that natural gas may have substantial upside when the turnaround does occur.

First, natural gas is trading at a material discount to oil on an energy equivalent basis. Second, the price of natural gas delivered in future is much higher than its spot price. Natural gas for January delivery closed at nearly $4.79 per million BTU, an 80% premium (or about $2.13 per million BTU) to the October futures price.

While natural gas investments do not appear particularly timely at present, there are varieties of investments long-term investors can monitor and profit from once the bull market in natural gas ensues.

One can play the natural gas theme by investing in the commodity itself through iPath DJ AIG Natural Gas ETN (GAZ).

Alternatively, one can invest in stocks of companies reasonably leveraged to natural gas. These include Anadarko Petroleum (APC), Chesapeake Energy (CHK), Devon Energy (DVN) and Canada-based EnCana (ECA).

Mutual fund and ETF investors can look at Fidelity Select Natural Gas (FSNGX) and SPDR S&P Oil & Gas Exploration & Production (XOP). While these bundled products are not entirely pure-plays on natural gas, they do offer the benefit of reducing company-specific risk.

Internal Sponsorship

Profit from Timely Sector Selections . . .

The AlphaProfit Sector Newsletter has enabled subscribers to gain with gold. We will seek to do the same with natural gas when the time is right. The Newsletter's Core and Focus model portfolios will be repositioned on Wednesday, September 30 when the newsletter completes 6 years of uninterrupted publication. Grab this opportunity to profit from timely sector selections!

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