An ETF for a Rebound in Natural Gas Prices

Demand is just one-half of the market though. Supply has been robust enough that the increase in demand hasn't affected natural gas prices yet. That may change, however, as natural gas producers shutter wells and shift production.

In April, rig counts declined for the first time in 16 weeks. This process is part of the bottoming process and natural gas prices may continue to slide until enough production is taken off the market.

Natural gas drillers are also shifting assets into oil drilling and exploration. Petrohawk's(HK) CEO said the firm would do more oil drilling. SandRidge(SD) bid for Arena Resources(ARD) to grow its oil reserves, and even Chesapeake Energy(CHK), the stock most investors think of when they hear natural gas, is talking about oil.

In addition to the voluntary production cuts from the industry, regulators may tighten the areas open to drillers. New York toughened watershed protections last week, closing off some areas of the Marcellus shale formation that stretches into much of the state. The EPA is also looking into the threat of water pollution and the trend in Washington at the moment would seem to favor some tightening of regulations.

All these factors point to a bottom in natural gas prices, but it doesn't mean the bottom is in. Bottoming is a process and the forces that will cause the next sustained rally in natural gas prices take time to build up. This gives investors the luxury of time in positioning themselves for the eventual upturn.

For ETF investors looking to play a bottom in natural gas, U.S. Natural Gas(UNG) is not the best choice. Fundamentally, natural gas prices may have further to fall in the near term and in the long run, I expect natural gas stocks will beat the fuel itself.

On top of that, regulatory issues are back in the spotlight as Washington turns to financial reform, and these have caused problems for UNG before.

The better ETF for this move is First Trust ISE-Revere Natural Gas, with the J.P. Morgan Alerian MLP Index ETN(AMJ) as a solid choice for conservative and income oriented investors. For more information on these funds, see my Ultimate Guide to Natural Gas.

Investors also have a much more volatile play in the form of the Jeffries TR/J CRB Wildcatters Exploration & Production Equity ETF(WCAT), which owns small and mid-cap oil and natural gas explorers and producers.

The fund has a 0.65% expense ratio and extremely low volume that has averaged 1,500 shares per day over the past three months, in addition to having only $4 million in assets.

I warned investors of the risks in this fund before in an article, but I expect this fund to outperform. Recently, top 10 holding Mariner Energy(ME) jumped almost 50% when Apache(APA) offered to buy the firm, and this has helped WCAT beat FCG thus far in 2010, 16.5% to 10.7%

-- Written by Don Dion in Williamstown, Mass.

>To order reprints of this article, click here: Reprints