Sunday, September 25, 2011

Crude Oil versus Natural Gas

I think it is finally time for oil to significantly underperform natural gas. the moment has been a long time coming, but evidence mounts (though don't expect any in this post).

a long-term chart of the crude oil / natural gas ratio shows the sustained and extreme overvaluation of crude to gas over the past couple years:

I expect the ratio to drop to 13 and after that down to 9 or 10. Even these are conservative targets taking both physical and historical references into account.

the structure of the futures market makes it difficult to exploit this outlook simply by buying gas contracts and shorting crude. My preferred strategy is to purchase certain depressed natural gas producers* during market panics (such as now) while shorting or otherwise betting against buoyant oil companies or crude oil itself when the market rebounds somewhat, as I believe it will. while I have have my eyes on ~1080 for the S&P, if it hits that target I expect the index to meander back into the mid-1200s before things really go to shit.

*we bought PVA late last week. The stock's been in free fall, very large short interest, extremely low price-to-book. just an extremely low quality stock, really. hopefully they don't go bankrupt.