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Natural Gas Heads for Super Contango

Many people think it's easy to switch between natural gas and oil, but in fact they serve different markets: 70% of crude oil goes towards transportation, whereas natural gas is split three ways between residential & commercial, industrial and electric generation demand. Switching from one to the other is a lengthy and expensive process and most of the switches have been made.

The international nature of crude oil means if people in Ulan Batur demand more oil, the price may change in New York. But a natural gas shortage in Mongolia will not raise American prices because there's no easy means to transport it. There were major discoveries of natural gas last year and New York Governor David Patterson is pushing to open up the Marcellus shale to drilling, with environmental concerns taking a backseat to the need for tax revenue.

On top of that, renewable energy currently is aimed at electricity generation, not transportation (though that may also change depending on the popularity of electric cars).

Natural gas has abundant natural reserves, excessive supply and reduced demand and is a competitive threat -- it was one of the hottest ETFs in the past three months, based on money flows.

As I warned almost two months ago, the fundamentals pointed to lower natural gas prices. I was right and prices have fallen. I've also warned against investing in U.S. Natural Gas (UNG) countless times.

UNG became a slow-moving target in the futures market that allowed savvy speculators to front-run its monthly contract roll. It already created an exacerbated the near-month contango and cost investors money each time it rolled. Now due to concern over pending regulatory changes, UNG ceased issuing new shares and trades at a whopping premium of 17%. The iPath Natural Gas ETN (GAZ) doesn't offer much advantage; it had an 8% premium at close yesterday.

Ironically, if we see a final super-contango cratering of UNG, it may create the conditions for the next bull market, but that could take months to years to play out, however, and depends on multiple factors. I've recommended First Trust ISE-Revere Natural Gas (FCG), which holds the stocks of producers and has outperformed UNG since March, as a better way to play natural gas if that's your desire. But unless another Katrina rips through the Gulf region, the outlook for natural gas prices is grim.

-- written by Don Dion in Williamstown, Mass.

At the time of publication, Dion had no positions in the stocks mentioned.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

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