The United States Natural Gas Fund Was Up On A Historic Down Day For Energy (NYSEARCA:UNG)

Summary

Yesterday, Monday, March 9th, 2020 was the worst day for oil prices since 1991.
It was an even worse day for the energy equity sector, with many energy stocks down over 40%, and even over 50%.
On a day when almost all energy equities were negative, natural gas related equities notched some gains, and natural gas prices finished higher too.
The reversal in dry natural gas prices across the curve sparked a gain in the United States Natural Gas Fund.
This beleaguered ETF is poised to move higher as dry natural gas prices continue their rise.
This idea was discussed in more depth with members of my private investing community, The Contrarian. Get started today »

I will go to my grave... believing that really loose monetary policy greatly contributed to the Financial Crisis. There were obviously problems with regulation, but when we had a 1% Fed Funds rate in 2003 after, to me, it was pretty obvious that the economy had turned (up) and I think the economy was growing at 7% to 9% nominal in the fourth quarter of 2003 and that wasn't enough for the Fed. They had this little thing called 'considerable period' on top of the 1% rate just so we would make sure that their meaning was clear. And it was all wrapped around this concept of an insurance cut… I've made some money predicting boom-bust cycles. It's what I do. Sometimes I am right. Sometimes I am wrong, but every bust I had ever seen was proceeded by an asset bubble generally set up by too loose policy..."

- Stanley Druckenmiller

"Try to buy assets at a discount rather than earnings. Earnings can change dramatically in a short time. Usually, assets change slowly. One has to know how much more about a company if one buys earnings."

- Walter Schloss

"A 60:40 allocation to passive long-only equities and bonds has been a great proposition for the last 35 years… We are profoundly worried that this could be a risky allocation over the next 10."- Sanford C. Bernstein & Company Analysts (January 2017)

"Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."- Sir John Templeton

"Life and investing are long ballgames."

- Julian Robertson

(Source: Author's Photo)

Introduction

On one of the worst days for the energy sector in modern market history, the United States Natural Gas Fund (NYSEARCA:UNG) finished higher by 5.9%, as natural gas prices rose across the futures price strip reversing earlier Monday morning losses.

Why did dry natural gas prices rise?

One reason, is that the significant fall in crude oil prices, which are down 49.0% as measured by $WTIC crude oil prices, with the United States Oil Fund (USO) down 49.1% year-to-date, will curtail associated dry gas production growth, as I outlined in an article I published yesterday, titled "The Long Oil, Short Natural Gas Trade Is Officially Dead."

Going further, not only will associated dry gas production growth be curtailed, associated dry gas production will decline outright.

Thus, even on one of the worst days in modern market history for the energy sector, natural gas prices rose, and they are poised to rise further as the probability of outright crude oil production declines increases.

Natural Gas Prices Finish Higher After Starting Lower

Yesterday morning, here is a snapshot from the CME Group (CME) of what dry natural gas prices looked like before the opening of the equity markets.

(Source: CME Group)

By the afternoon, even though crude oil prices were still down over 20% on the day, and energy equities cratered into the close, natural gas prices had reversed their earlier losses of approximately 3%, and now were over 4% higher across the futures curve.

(Source: CME Group)

For the day, the United States Natural Gas Fund ended up 5.9%, which was in sharp contrast to the United States Oil Fund, which finished lower by 25.3% on the day.

(Source: Author, StockCharts.com)

Digging deeper into the underlying energy equity moves, the outperformance of natural gas related equities stood in sharp contrast to the free fall in oil related equities.

Quantifying The Damage In The Energy Sector & Showing The Sharp Contrast

My colleague, Lothar Grall, put together two charts for members of The Contrarian that I expounded upon in this member article.

The first chart shows the energy equity performance of stocks in the Russell 1000 (IWB) alongside their volume.

(Source: Lothar Grall, The Contrarian)

Looking at the above, some of the price movements, and relative volume changes were amazing.

A few standout percentage gainers and losers from the chart above are listed as follows:

EQT Corp. (EQT) - up 10.5%

Cabot Oil & Gas (COG) - up 3.8%

Schlumberger (SLB) - down 27.4%

Diamondback Energy (FANG) - down 44.7%

Marathon Oil (MRO) - down 46.9%

Occidental Petroleum (OXY) - down 52.0%

Continental Resources - down 52.5%

Targa Resources (TRGP) - down 52.9%

Apache (APA) - down 53.9%

Kosmos Energy (KOS) - down 59.0%

Centennial Resource Development (CDEV) - down 63.2%

It was truly a remarkable day in the energy equity sector, as the energy equity returns from the Russell 1000 Index above show, and that only tells part of the story. The pipeline sector was obliterated, with the Alerian MLP ETF (AMLP) down 28.1%, and leveraged MLP ETF's and closed end funds, like the InfraCap MLP ETF (AMZA), which declined 42.3%, and the Cohen & Steers MLP Income and Energy Opportunity Fund (MIE), which declined 28.5%, down even more.

Against this horrid backdrop of returns, the positive returns in EQT Corp., and Cabot Oil & Gas, the number one and number four domestic dry natural gas producers, which again gained 10.5%, and 3.8% illustrate the price strength in the natural gas sector versus the oil sector, spurred by the underlying move higher in natural gas prices.

Look For Strip Prices To Improve Further & UNG To Benefit From Backwardation

As associated gas production from liquids and dry gas production roll over, this will send the whole natural gas futures curve higher.

(Source: Lothar Grall, The Contrarian, EIA Drilling Productivity Report)

The realization that lower oil prices will limit associated gas production is helping the whole natural gas futures price curve again this morning.

(Source: CME Group)

Once concerns about supply really start to set in, the front month contracts will trade above the further out month prices, putting the natural gas futures price curve into backwardation.

Ultimately, this will provide a positive tailwind to the United States Natural Gas Fund, and its leveraged counterpart, the VelocityShares 3x Long Natural Gas ETN (UGAZ).

Normally these two suffer from a negative roll yield, which has crushed the long-term returns of UNG, as shown below.

(Source: Author, StockCharts.com)

Clearly, looking at the chart above, UNG is not a long-term hold when futures prices are in their normal state of contango, so it is very important to be aware of the pricing dynamics surrounding the roll yield.

Closing Thoughts - On A Black Monday For The Energy Sector, Natural Gas Stood Out

From my perspective, the energy narrative completely changed over the past five days or so, going from an investing landscape where almost all market participants expected an avalanche of natural gas from associated gas production growth, to an investing landscape that is now grappling with how much associated gas production, and overall natural gas and oil production will decline.

This change in narrative has massive implication for investors beyond the surface headlines of an oil price war between Russia and Saudi Arabia.

The performance of energy equities yesterday signifies the magnitude of the impending changes, and it is not too late to get in on the ground floor of the primary beneficiary, which is of course natural gas.

Bigger picture, I think it's only a matter of time until a historic capital rotation from technology equities to energy equities and from growth-to-value takes place.

(Source: Bloomberg)

With this investment backdrop, the hidden historic opportunity, the proverbial forthcoming golden age of active investing, lies in cast-aside, out-of-favor, non-correlated equities - including energy equities, which are historically loathed. More specifically, from my vantage point there's a generational opportunity in the downtrodden leading U.S. natural gas producers. Several of these were S&P 500 Index stalwarts 10 years ago, yet they have been summarily kicked to the curb even though their reserves and cost of production are materially better - sometimes by a factor of three times or more. These producers have collectively lowered their breakeven profitability levels dramatically vs. their peer group from a decade ago. As a result net income and, more important, free cash flows, should surge at higher natural gas prices - particularly above $3, which I believe is a mathematical inevitably.

The Contrarian

There is historic opportunity in the investment markets today. I have spent thousands of hours analyzing the markets, looking for the best opportunities, looking to replicate what I have been able to accomplish in the past. From my perspective, the opportunities in targeted out-of-favor equities today are every bit as big as the best opportunities in early 2016, and late 2008/early 2009. For further perspective on these opportunities, consider a membership to The Contrarian, sign up here to join.

This article was written by

KCI Research Ltd.

27.63K Followers

KCI Research, aka Travis, has been a financial professional for over 20 years. Formerly a director of research at a mid-sized RIA, and one of four strategic investment decision makers at one of the largest RIA's in the United States, Travis founded his own boutique investment firm in February of 2009. He specializes in against grain investing backed by real-world wisdom and experience by targeting out-of-favor, contrarian investment opportunities.

Travis is the leader of the investment group The Contrarian where he shares premium research and uncovers investment gems hidden in plain sight. Travis shares an all weather portfolio for minimal volatility along with a concentrated best-ideas portfolio Learn More.

Analyst’s Disclosure: I am/we are long UNG, COG, EQT, OXY, AND SLB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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