Because the nominal risk-free rate of return is zero, it costs investors nothing if gains in natural gas and oil investments are delayed. The real rate of return on U.S. government short-term securities is negative considering that monetary inflation continues every day. That was the case for twenty years beginning in the mid 1930s when a Democrat was the U.S. president at a time of high economic uncertainty.
Like today, bonds earned a modest real return for about ten years and then the return was negative for forty years. From the depth of the most uncertain times, equities were winners for thirty years. In other words, an investor in equities who had the patience and fortitude to remain invested lost nothing by not being in cash or bonds instead. Considering our stance that natural gas futures may have bottomed, we believe we have nothing to lose from an investment point of view if the gains take longer. Four income-paying buy recommendations, Canadian Oil Sands Trust (COSWF.PK), Dorchester Minerals (DMLP), Hugoton Royalty Trust (HGT) and San Juan Basin Royalty Trust (SJT) make attractive cash distributions while we wait. Two small cap buy recommendations, Birchcliff Energy (BIREF.PK) and Cimarex Energy (XEC) reinvest cash flow efficiently.
New Measure of Near-Term Price Trend
Though patient, we also pay attention to near-term trends. Frequently referring to the comparison of price to 200-day average, we add our own wrinkle to the popular measure – Enterprise Value to 200-day average. Enterprise Value, or Market Cap and Debt, removes financial leverage when ranking stocks by degree of deviation from moving average. As a result we can turn the momentum measure into a ranking comparable to what we do with McDep Ratio to help spot price anomalies.
For example, COSWF ranks lowest in the Canadian Income Trust group by both the McDep Ratio and the EV/200day measure. We think that means the stock is attractive from a contrarian point of view on both value and stock price trend.
In the same group, we see that Enerplus (ERF) has recently moved up in the EV/200day ranking. We find that encouraging because the stock had our lowest McDep Ratio ranking not long ago.Among small cap independent producers, the formerly popular natural gas growth stocks Ultra Petroleum (UPL), Petrohawk (HK), and Range Resources (RRC) increasingly trade at low EV/200day ratios. In the process, their McDep Ratios become more supportive of new commitments.
At the same time, we will be inclined to keep our buy recommendation on XEC as long as EV/200day is above 1.0. When the McDep Ratio is higher we encourage rebalancing, or trading around a core position, as a natural process in investment management.
Originally published on September 10, 2010.