A warm winter doesn’t help the price of natural gas catch up at all with the price of oil. Warm winters mean that people use less of the stuff to heat their homes. It means higher inventories of natural gas. So even though the price of oil soars, the price of natural gas languishes. Old salts of the energy markets steer by the lights of a roughly 6-to-1 ratio between the prices of oil and natural gas. Today, that rate is closer to 13-to-1. Either oil is expensive or natural gas is cheap.

I think natural gas is cheap. I think it’s one of the best buys on the commodity menu right now. There are a few things that make me comfortable with the idea that those rich natural gas inventories won’t last much longer.

For one thing, as Grant’s Interest Rate Observer recently pointed out, Americans are living in bigger and bigger houses. Natural gas is a popular fuel to warm them. The amount of gas Americans use to heat their homes is rising per unit of cold. Grant’s quotes Leigh Goering, who runs a natural resource fund for Chilton. Goering says, “We’ve reached a point where we need warmer-than-normal winters for the system to operate properly.” And if the forecasters are wrong and we get a good old-fashioned cold winter? The imagination reels. Suffice to say, the price of natural gas will rise.

The size of homes was an interesting angle I had not considered before. It’s like an echo (or an aftershock) of the housing boom. The great housing bubble financed bigger and bigger homes that are costlier to live in. Even though the boom has turned to bust, its effects will linger on as a drag on America’s pocket books for years to come.

The second big issue is the new energy bill, which was kind to ethanol, to put it mildly. The bill requires a five-fold increase in ethanol production by 2020. The popularity of ethanol is one of the best things that ever happened to the natural gas industry.

That’s because ethanol is a great natural gas guzzler. Most ethanol distilleries burn it to make ethanol. And we have many new ethanol facilities coming online in 2008 — the vast majority of them will burn natural gas. But there’s more. American ethanol producers also need a lot of corn. Corn is also the biggest consumer of fertilizers among the big row crops. Fertilizers can make up 40% of the cost to produce corn. And some 90% of the cost of fertilizers depends on the price of natural gas. It’s a double whammy. Making ethanol itself burns gas, and producing the corn burns even more of it.

Finally, there are a number of new utilities coming online that burn natural gas. In 2000, nearly 95% of the new electric capacity in the U.S. burned natural gas. This has lead to a surge in natural gas usage post-2000. (See nearby chart titled “Natural Gas — Running a Hot Second.”) Since natural gas burns cleaner than coal or oil, it’s in an enviable position in a world suddenly highly conscious of its carbon emissions:

Add all that up and you’ve got a healthy backdrop to the demand for natural gas.

Sincerely,

Chris Mayer
February 25, 2008

P.S.: This is a theme that I introduced to my Capital & Crisis readers last year. We have already seen one of our natural gas plays shoot up 36% in just a few months. But we aren’t done yet. I expect to see that one rise even further as people start to realize this trend.

The Market is Severely Undervaluing Natural Gas was originally featured in the Penny Sleuth.

The debt-dealers are getting desperate. And you could cash in while the housing market starts to cash out. More on that in a minute…

Their message is smeared on billboards, TV and Internet banner ads — the lenders want you to cave in and cash out that home equity. One advertisement in particular is sure to catch your eye: A house made of money, with the spigot turned on and money pouring right out into your hands.

Cash out that equity! Debt doesn’t matter; money is FREE! These are the messages they pound into your skull. After all, this is the only way you’re getting a raise. Real salaries are stagnant or dropping… So people have cashed out and put the money into cars, clothes and maybe even another garage out back for that new car.

Then along came a new career: house flipping. Last year, you could have made a lot of money simply by buying a house, holding it for a few months, then selling it for a handsome profit.

Only the more intellectual news outlets mentioned the idea that the housing market was in bubble mode last summer, but now you’d be hard pressed to find someone who hasn’t heard the phrase “housing bubble.” After all, what goes up must come down.

And down they go. Homebuilders are warning investors that this year might not be as great as 2005. From the Associated Press:

“Shares of homebuilders took a hit [Feb. 7] after Toll Brothers Inc. said new orders fell in the first quarter and home deliveries this year would be weaker than expected.

“The Philadelphia Housing Sector Index, a national index based on share prices for 21 companies, fell by more than 1% as investors worried about signs the housing market has cooled. Shares of Toll Brothers sank $1.73, or 5.5%, to close at $29.47 in trading on the New York Stock Exchange.”

Downturn in Real Estate: Look to Lending Instead of Housing

So what should investors do as the bubble continues to lose air? Well, you should anticipate the housing market to struggle this year because the Fed will continue raising rates. And when the Fed raises rates, payday lenders make a lot of money, as do loan collectors — the folks who collect the bad loans when people default due to high interest rates. And many of these are small-cap companies.

Here are some companies you might want to research:

– Portfolio Recovery Associates (PRAA: NASDAQ); market cap: $733 million; price: $46
– Advance America (AEA: NYSE); market cap: $1.1 billion; price: $13
– QC Holdings (QCCO: NASDAQ); market cap: $266 million; price: $13
– First Cash Financial Services (FCFS: NASDAQ); market cap: $535 million; price: $34

And for those who deny the potential after-effects of the housing bubble, take a look at some other economies that have been affected.

You only need to turn to other markets around the world to see the end result of the housing bust. Just look at this excerpt from Bill Fleckenstein’s MSN Money column that ran today:

“And last week brought evidence of how the problem has affected Australia. This, from ‘Slump hits home,’ a story in the Sydney Morning Herald. As writer Matt Wade chronicles, the slow unwinding of that country’s housing bubble is starting to hurt a bit, after having been somewhat benign last year:

“‘The casualty list from Sydney’s property boom is growing. First, a generation of first-home seekers found itself priced out of the market. Then, as house prices finally sagged, thousands of overstretched investors and owner-occupiers fell into trouble.’

“He goes on to point out the insidious nature of bubbles… which is why I detest the Fed so much, because of its role in aiding and abetting idiotic activities that ultimately harm society…

“‘Now, even vulnerable people who had nothing to do with the fluctuations of property prices could be hurt. As the State Government struggles to repair the holes in the budget caused by stagnant property revenue, the aftermath of the boom could be painful for bystanders like the old, the sick, the disabled and the poor. The suffering would occur if the Government were forced to cut services and lift charges for these groups as it covers the shortfall in property taxes.’”

Until next week,

Gunner
february 13, 2006

P.S. Small-cap gold stocks are another key investment to keep in mind as the housing bubble fizzles out. In fact, Sala Kannan offers some important advice in her Friday Sleuth column about why you should buy small-cap gold.

Downturn in Real Estate: Protect Yourself from the Real Estate Recession was originally featured in the Penny Sleuth.