Natural gas, the worst-performing and most volatile commodity of the past decade amid a glut in supply, is replacing gold as a haven for commodity investors as the metal slumps.
The heating and power-plant fuel produced the best risk- adjusted returns of 24 commodities in the Standard & Poor’s GSCI index over the last 12 months, rebounding from the worst ranking in the prior 10 years, the BLOOMBERG RISKLESS RETURN RANKING shows. Gold, the decade’s top performer, and silver tumbled as a stock market rally and a rising dollar curbed demand for the metals as a refuge.
Power plants and factories are stepping up their use of gas after a surge in production of the fuel from shale formations pushed prices to a 10-year low last year. Rising demand may make historically volatile gas a haven, Jeffrey Currie, head of global commodities research at Goldman Sachs Group Inc. in New York, said in an April 16 research note. Banks from Goldman Sachs to Citigroup Inc. are boosting their forecasts for natural gas prices while cutting their estimates for gold.
“Natural gas is emerging as a clear winner among commodity investments,” Teri Viswanath, director of commodities strategy at BNP Paribas SA in New York, said in a phone interview on May 1. “The late-winter rally has fueled expectations that gas will outperform alternative investments in the sector.”
Natural gas futures for June rose 4.3 cents, or 1.1%, to $3.963 per million British thermal units on the New York Mercantile Exchange at 1:05 p.m. today. The futures have advanced 65% over the past year. Gold for June delivery on the Comex in New York climbed 1.3% to $1,468 an ounce. Silver for July delivery gained 0.4% to $23.905 an ounce. Gold is down 9% over the past 12 months and silver 19%.
Gas has climbed a risk-adjusted 0.7% over the past year, followed by unleaded gasoline and corn, both with 0.5%, data compiled by Bloomberg show. Gas showed the best improvement by risk-adjusted return from the previous 10 years.
The 24 commodities in the GSCI index had an average 0.2% risk-adjusted decline in the 12 months through yesterday. Silver had the worst reversal in risk-adjusted returns, followed by copper and gold. Gold, the best commodity by risk-adjusted return in the prior decade, fell to fourth from bottom.
The risk-adjusted return, which isn’t annualized, is calculated by dividing the total return by the volatility, or the degree of daily price variation, giving a measure of income per unit of risk. A higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
For most of the past decade, investors have been burned by gas. Prices rose as high as $15.78 in 2005, then fell to a 10- year low of $1.902 in 2012. Even as it rebounds this year, it is still the most volatile commodity in the GSCI index, with a reading of 40.4, compared with 46.7 in the prior decade.
Among the casualties of the price swings is the biggest leveraged buyout in history, the $48 billion takeover of Dallas- based Energy Future Holdings Corp., known as TXU Corp. before it was bought in 2007. KKR & Co., TPG Capital LP and Goldman Sachs, who led the deal, took a gamble that rising gas rates would push up power prices and give its nuclear and coal-fired plants a competitive advantage.
As prices fell, earnings declined and the power company struggled under its debt load. Energy Future Holdings this month reported its ninth consecutive quarterly loss as the value of contracts to lock in the price of natural gas declined. The company is seeking to restructure at least $32 billion of debt.
Improved technology for extracting gas from shale formations across the U.S. has unlocked record supplies, driving prices lower over the past years. Producers use a technique known as hydraulic fracturing, or fracking, which involves pumping water, sand and chemicals underground to release gas embedded in rock.
The U.S. surpassed Russia as the world’s largest gas producer in 2009, data from BP Plc show. The boom in oil and natural gas output helped the U.S. cut its reliance on imported fuel. The country met 84% of its energy needs in 2012, the most since 1991, Energy Information Administration data show.
“The shale revolution has helped shape the improving economic environment in the U.S., making U.S. natural gas and the U.S. economy the new safe haven,” Goldman’s Currie said in the April 16 report.
U.S. gas output may climb 1% to a record 69.9 billion cubic feet a day this year, according to the EIA. Soaring production and mild weather brought inventories of the fuel to an all-time high of 3.929 trillion cubic feet in November.
By April of last year, prices had dropped so low that Jeffrey Gundlach, the top performing bond-fund manager, compared it with gold in 1997, before the surge in the metal’s price. As 1997 ended, spot gold traded at its lowest price since 1979. The precious metal retreated 21% for the year and posted losses in each of the next three years. Since then, the price has risen more than fivefold, gaining for 12 straight calendar years.
The low price of gas and ample supply have fueled demand from industrial consumers and electricity generators. Consumption of the fuel by industrial users, including chemical companies and aluminum plants, increased 4.3% in February from a year earlier to 22.2 billion cubic feet a day, the most since February 2004, according to the most recent data from the EIA, the Energy Department’s statistical arm. Demand rose 2% from January, the seventh consecutive monthly increase.
Consumption of the fuel by power plants surged to 35.27 billion cubic feet a day in July, the highest in records going back to 1990. U.S. power plants produced an equal amount of electricity from gas and coal in April 2012 for the first time on record, EIA data show. Each fuel represented 32% of the electricity generated that month, with the share from gas climbing from 23% from a year earlier while coal’s contribution dropped from 41%.
“We’ve had high gas demand, which means lower storage levels,” Anthony Yuen, a strategist at Citigroup in New York, said in a June 1 phone interview. “That’s the key reason why natural gas is still alive and well while other commodities have declined.”
The increase in gas demand will probably accelerate after 2015, Scott Hanold, an analyst at RBC Capital Markets in Minneapolis, said in a note to clients April 5. Consumption will gain about 6% from 2015 through 2020 as new gas-fired power plants are built and industrial use rises, RBC said.
Prices rebounded this year as cold weather erased an inventory surplus that had reached a six-year high of 61% over the five-year average in 2012. March temperatures were the lowest for that month in 11 years, according to the National Climatic Data Center, an agency of the National Oceanic and Atmospheric Administration. Gas stockpiles totaled 1.777 trillion cubic feet in the week ended April 26, 6.2% below the five-year norm and 31% below last year’s level for the period.
The boost in weather-driven demand for natural gas comes as production growth slows. The number of rigs drilling for gas in the U.S. fell by 12 to an 18-year low of 354 last week, data from Baker Hughes Inc. in Houston showed on April 26. The total has dropped 15% this year. Gas rigs reached an all-time high of 1,606 in August 2008.
Gas price swings will probably persist, BNP’s Viswanath said. Inventories remain abundant and mild summer weather may curtail consumption by electricity generators, she said.
“The EIA data continues to show healthy supplies,” Viswanath said. “Producers have quite a bit of spare supply capacity and they may be encouraged by this run-up.”
Gas tumbled the most in nine months on May 2 after a government report showed U.S. stockpiles expanded by more than forecast. Prices slid 7%, the biggest one-day decline since Aug. 2.
Meanwhile, gold has lost 12% this year through May 1, plunging into a bear market in April, amid bets that economic recovery in the U.S., the world’s biggest economy, may reduce the precious metal’s appeal as a store of value.
The turn in the gold cycle is quickening and investors should sell the metal, Goldman Sachs analysts Currie and Damien Courvalin said in an April 10 recommendation that returned 5.4% in three days.
Gold ceased to be the haven for investors after it fell when the euro was close to collapse last year, billionaire investor George Soros said in an interview with the South China Morning Post published April 8. Soros cut his stake in the SPDR gold fund by 55% in the fourth quarter, a filing with the Securities & Exchange Commission shows.
John Paulson, the biggest gold bug on Wall Street, lost 27% in his gold fund last month, bringing declines for the year to about 47%.
UBS AG said April 2 that the commodities supercycle has ended and that returns are unlikely to match the performance of the past decade, joining Citigroup, which called the end to the cycle in November. There will be “many more losers than winners” for commodities this quarter, Citigroup analysts including Edward L. Morse, the bank’s global head of commodities research, said in an April 12 report.
Money managers increased bullish bets on natural gas for 11 consecutive weeks as the futures soared. Hedge funds boosted wagers on rising prices in the week ended April 30 to the highest level in records dating back to January 2010.
Goldman Sachs raised its forecast for 2013 natural gas prices on April 4 to $4.40 per million British thermal units, a 17% increase over the previous outlook. Citigroup boosted its estimate 21% to $4.30 per million Btu on April 12.
“We’ve been fielding a barrage of questions from investors who are looking at natural gas,” Viswanath said. “Gas had been in the doldrums for the past four years and investors have been waiting for an opportunity to buy. The thinking is that with the moderation in inventories, this might be the ideal time.”