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Commodities Report by Vince Stanzione

With natural gas now so cheap relative to crude oil prices, is now the right time to buy?

Firstly, let us define 'cheap'. Stocks and commodities can remain cheap for a very long time, and while the fundamentals may sound great, you could be locked into a trade that's going nowhere or will go against you for months or even years. Many traders said shares in Japan were cheap in 1999. Yet ten years on, they're still cheap and you have just wasted a decade.

The recent interest in natural gas (NG) has been brought about because the oil price has hit $70 a barrel, whereas natural gas is hovering at less than $4 per million metric British thermal units. Therefore, the logic of the trade is that natural gas is cheap compared to crude oil.

However, before you go all-in and bet your house on NG, who says that this relationship cannot continue for some time longer? While this 17.5 ratio (1 barrel/1 mmbtu) sounds a bargain against the normal 10 to 12 ratio, we still need to dig a bit deeper.

NG does not have the same price controls as oil does, with OPEC opening and closing the taps to keep prices higher. While the gas drillers are cutting production, there remains a glut of natural gas (stockpiles are 22 per cent larger than the five-year average according to the US Energy Department). The past few years has also seen new technology making the extraction of NG from shale viable.

The main users of NG are factories and power plants - using around 58 per cent of all natural gas. As the economy and manufacturing weakened, so did demand for NG.

So while NG looks historically cheap, especially in relation to oil, we still have a large surplus. But here comes the positive - at anything lower than $3.50 per mmbtu, it's just not worth drilling.

In fact, rigs are being closed, with the number of US rigs plunging by 56 per cent within nine months, the steepest drop in two decades. So we know that new supply is going to drop, although this will take time to filter through.

Another positive for the NG bulls is that we are now entering into hurricane season in the US. Many oil and gas rigs are located in areas vulnerable to hurricanes, which could disrupt supplies and see prices spike higher.

While NG is a volatile market, it has a seasonal tendency to bottom around mid-July. It then peaks at the end of October, so we are entering this bullish period.

To buy or not to buy

Based on current demand/supply, I see no reason to own natural gas yet, even if it looks 'cheap', as this could continue. But I am watching for any spikes in price or increase in hurricane activity in July - if this is the case then yes, I will start buying. The easiest way would be the ETC Natural Gas for December 2009, currently 70 cents. However, you can spread bet in pounds, dollars or euros per point. You can also buy the ETC via a stockbroker, the symbol being LSE:NGAS. For those looking for a bit more risk reward there is also a Leveraged Natural Gas (LSE:LNGA) that aims to move by twice the daily price move of natural gas less interest charges.

Staying with commodities, my favourites are the ones not making the big headlines, including cotton, coffee and sugar. I also like corn, wheat and soyabeans.

Short term, I am not a fan of gold or silver, as they are in a seasonal weak period. As we move towards the end of August, however, I will take another look at both.

One metal I have been steadily buying is palladium, which is around $250 an ounce and up 35 per cent this year. Nevertheless, I still see it as offering value compared with platinum. Palladium can be used in jewellery and industrial applications such as catalytic converters, while it is also purchased for investment purposes. You can easily spread-bet palladium or buy the ETC, which is backed by physical palladium (LSE:PHPD).