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Another Nasty Oil Correction Is Close at Hand

By Ian Davis
Monday, July 21, 2008

On June 16, I predicted an imminent, "nasty correction" in crude oil.
 
That correction may now be underway. Crude oil plummeted more than $15 in the last three days. And a lot more downside is in the works. I think oil could be headed as low as $50.
 
But today, let's talk natural gas...
 
If oil crashes, natural gas will fall, too. Natural gas is like crude oil's younger sibling. The natural gas price shadows the price of crude oil wherever it goes.
 
The two have a follow-the-leader relationship because about 18% of natural gas usage can be switched to petroleum products. Also, drilling these two forms of energy requires many of the same resources... like geologists, drill-rig operators, and rigs.
 
The following chart shows the close relationship between crude oil and natural gas.
 
 
 
As you can see, the two energies rarely diverge by much. However, the price of crude oil has outpaced natural gas in the last couple of years. That's not unusual... the natural gas price often lags the price of crude oil.
 
Like an older brother, the crude oil market is much bigger than the natural gas market. So the price of crude oil is determined on the world stage. But natural gas prices are determined by region. So the price of crude oil drives the natural gas price and not vice-versa.
 
According to a Department of Energy study, if crude oil pops up 20%, natural gas climbs 16% over the following year. Eventually, natural gas rises the full 20%. But the price rises more slowly as the fuels return to their normal relationship. (On average, a barrell of oil costs eight times as much as 1 million BTUs of natural gas.)
 
So natural gas has been playing catch-up for the last two years. Now that crude oil is falling, we'll see the same thing in reverse. Natural gas will also fall, but more slowly than crude oil.
 
Let's say crude oil does fall to $50 (a huge fall, but not impossible). That would be a 66% decline. If the historic relationship between the two fuels reasserted itself, natural gas would be $6.24 per million BTU. That's a more modest drop of 52%.
 
So I don't think natural gas has as much downside risk as oil... but the picture is still ugly. My advice is to stay out of both energy markets until the correction plays out.
 
Good investing,
 
Ian Davis




Market Notes
Technology bellwether IBM hits all-time high.
 
Generic drug maker Barr Pharmaceuticals soars on buyout, hits new high.
 
American trucking stocks take off... Werner Enterprises, Knight Transportation, J.B. Hunt, Pacer International, Old Dominion Freight, HeartLand Express, and Universal Truckload hit new highs.
 
Earnings today... Apple, Bank of America, Merck, Schering-Plough.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1221.53 +1.3% +10.1%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
Change
52-Wk
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%

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