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Checking in on Our High-Income Natural Gas Trade

By Matt Badiali, editor, S&A Resource Report
Wednesday, November 14, 2012

Is it time to buy gas royalty trusts yet?
Royalty trusts are among my favorite business models on the planet. They simply collect cash from oil and gas wells drilled on their lands.
They are passive, low-risk investments that, if bought at the right time, can provide commodity investors with double-digit yields... and you don't have to depend on commodity prices rising.
When commodity prices are falling, however, it can get ugly. And that's where we were early this year.
In April, I warned you that natural gas royalty trusts were headed for a fall. At the time, I noted that falling natural gas prices would significantly decrease revenue for many of these energy trusts.
Let's look at how San Juan Basin Trust (NYSE: SJT), one of my favorites in the sector, has done since then...
San Juan Basin Trust (SJT) Down 24% Since April
In short, it was crushed. The price is down 24% since April... which would more than wipe out all the benefits of a high yield.
San Juan fell because natural gas prices plunged from about $4.75 per thousand cubic feet (mcf) in mid-2011 to under $2 – their lowest price since 2009.
But since that low, natural gas has gained more than 75%. It's over $3.50 per mcf. So is it time to buy back in?
Trying to predict natural gas prices is a sucker's bet... But low prices are bringing on new demand for natural gas, especially from power plants switching over from coal. If prices get too low, producers will shut in wells, reducing supply and pushing prices right back up. And if prices rise, we'll see more production from the country's huge new natural gas supplies, pushing prices right back down.
So it's reasonable to figure this year's range – from $3.80 per mcf to as low as $1.80 – will cover most of what we'll see from natural gas over the next few years. And that means this year's dividends will be about as much as we can expect from natural gas royalty trusts over the next few years.
San Juan has paid out an average $0.07 per month in dividends so far in 2012. That works out to $0.84 per year. When you're investing in commodities, you want to be paid for taking on risk, so I like to own these trusts when they're paying out double digits. That would put my rough "buy" price for San Juan between $8 and $9. Right now, it's going for more than $13... So it's not time to buy yet.
I did similar "back of the envelope" math for San Juan's peer group... And it turns out, some of them are already in "buy" range or close to it. Take a look...
Royalty Trust
Estimated Dividend Per Year 
10% Yield Price 
Current Price 
San Juan
Sabine Royalty
Permian Basin
That's not to say that the share prices won't fall from here... they could. Natural gas prices could return to their lows – or past them – and stay there. That would bring natural gas royalty trusts down farther.
But if I'm right about the range we can expect for natural gas – or if it climbs more than I expect – now is a good time to start looking for high yields.
Good investing,
Matt Badiali

Further Reading:

Back in April, Matt forecast a downturn in royalty trusts. Today, the four on his watchlist have fallen to near-bargain levels. See why he predicted the fall here: A Dangerous Income Trap for Commodity Investors.

In The Daily Crux
Market Notes
Gold stocks are avoiding the market-wide weakness... Eldorado, Yamana, and Agnico-Eagle are up 5%-plus over the past month.
Home Depot breaks out to a fresh all-time high as latest results show a housing recovery.
Another solar stock bites the dust... Trina Solar plunges 87% over the past year and a half.
Silver prices are up 17% in the past three months, despite a recent pullback.
Market Watch
Symbol Price
S&P 500 1374.53 -0.4% +8.8%
Oil (USO) 31.41 -0.6% -17.8%
Gold (GLD) 167.10 -0.2% -3.9%
Silver (SLV) 31.40 +0.1% -6.9%
U.S. Dollar 81.10 +0.1% +5.5%
Euro 1.27 -0.1% -7.7%
Volatility (^VIX) 16.65 -0.2% -44.6%
Gold Stocks (^HUI) 469.51 -1.2% -22.2%
10-Year Yield 1.59 -1.2% -22.8%

World ETFs
Symbol Price
Singapore (EWS) 13.05 -0.6% +14.5%
USA (SPY) 137.79 -0.4% +11.1%
S. Africa (EZA) 65.85 -0.6% +6.2%
S. Korea (EWY) 57.13 -1.0% +5.0%
Taiwan (EWT) 12.71 -2.0% +3.4%
Canada (EWC) 27.71 -0.6% +1.6%
China (FXI) 35.98 -1.6% -2.2%
Japan (EWJ) 8.87 +0.1% -2.8%
Israel (ISL) 12.77 +0.2% -4.3%
India (IFN) 22.18 -0.7% -5.6%
Lat.America (ILF) 41.22 -0.4% -6.9%
Russia (TRF) 13.81 -1.7% -15.2%

Sector ETFs
Symbol Price
Construction (PKB) 15.99 -0.2% +37.5%
Media (PBS) 15.90 -0.1% +21.9%
Health Care (IYH) 81.94 -0.5% +19.6%
Consumer Svcs (IYC) 84.21 +0.2% +19.0%
Financials (IYF) 57.50 -0.6% +18.3%
Biotech (PBE) 22.37 -0.5% +15.6%
Retail (PMR) 24.86 +0.3% +15.5%
Real Estate (IYR) 62.68 -0.3% +15.3%
Insurance (PIC) 16.86 -0.3% +13.5%
Water (PHO) 19.18 -0.2% +12.8%
Telecom (IYZ) 23.33 -0.5% +12.6%
Industrials (IYJ) 69.88 -0.4% +11.3%
Defense (PPA) 19.99 -0.1% +11.1%
Big Tech (QQQQ) 62.98 -0.7% +10.0%
Software (PSJ) 26.22 -0.5% +5.1%
Transportation (IYT) 89.74 -0.1% +2.1%
Utilities (XLU) 34.51 +0.4% +0.7%
Basic Mat (IYM) 65.54 -0.4% -2.2%
Semis (PSI) 13.55 +0.0% -7.3%
Nanotech (PXN) 5.62 -0.7% -10.4%
Alt. Energy (PBW) 3.67 -2.1% -33.9%

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