The market’s negative sentiment toward the energy sector has created a strong buying opportunity in the natural-gas space, according to Harry Rady, manager of the Rady Contrarian Long/Short Fund Ticker:(RADIX).
Mr. Rady, who manages $270 million as chief executive of Rady Asset Management LLC, agrees with the general consensus that the fundamentals in the natural-gas sector “stink.” But he also believes that the market has gone too far in downgrading many of the natural-gas companies.
“Given the low level of prices and the negative sentiment right now, it will only take a little bit of good news to force money managers to start covering shorts and drive a rally in natural-gas stocks,” he said.
Much of the market is focused on the declining price of natural gas, currently at around $4 per British thermal unit. That compares with $11 per BTU in June 2008.
The commodity’s tendency toward volatility was illustrated last fall when the price spiked 22% to $6.60 per BTU between Sept. 4 and Oct. 20.
“There are so many variables that can drive the price of natural gas, and that makes it a very volatile commodity,” Mr. Rady said. “A relatively small movement in natural-gas prices could translate to a big move by [natural-gas-company] stocks, and the bearish sentiment has driven prices so low that people are forgetting how quickly things can change.”
Energy now represents 25% of Mr. Rady’s portfolio, and two-thirds of that energy allocation is dedicated to natural-gas stocks.
One of his biggest holdings is Chesapeake Energy Corp. Ticker:(CHK), which has seen its stock price decline by more than 70% since June 2008 to around $21.
“The stock prices are discounting today’s [natural-gas] prices into the future, which is why natural-gas prices don’t have to increase much to drive stock prices higher,” he said. “The empirical data show that people get surprises regularly, and the unexpected should be expected in this space, because at least a couple times a year, we get something that affects the equilibrium in this area.”
Another energy play is Cobalt International Energy Inc. Ticker:(CIE), a company that is mostly in oil drilling and exploration.
This stock, which has fallen by 50% since January to around $8 per share, is uniquely exposed to President Barack Obama’s drilling moratorium in the Gulf of Mexico; Cobalt was getting ready to start drilling when the moratorium was introduced, and never got started.
“This is a situation where the market overreacted,” Mr. Rady said. “Even if it takes two years for drilling to return to the gulf, the company’s proven reserves places the stock at $20 per share, which means the assets are worth two or three times the current stock price.”
He acknowledged that “time is money,” but said Cobalt has enough money to wait out the moratorium.
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