Mr. Market is about to heal America’s collective amnesia.

Investors will once again remember why they were selling stocks last March, and they will also remember why they used to invest in natural gas.

Share prices have gained a lot of ground during the last few months, even though the economy has not. The major averages have rallied about 40%, but many stocks are up a whole lot more than that. Seventeen of the thirty-three stocks I have recommended to the subscribers have gained more than 50% since those March lows. Eight are up more than 100% and one is up more than 200%.

Robust rallies like these are not uncommon, even in the worst of markets. By now, you’ve probably read about how the stock market rallied 41% in early 1930 after the crash of 1929. Yet that rally fizzled and the stock market tumbled to even lower lows, and had years of hard slogging ahead of it.

I’m not saying this is 1930, but I would caution against overconfidence. Investors should be looking to hedge their bets after this recent rally… and should be looking for a margin of safety. I believe natural gas might be a great place to hide.

Natural gas is, simply put, super cheap. As most other commodities – including oil – have rallied, natural gas has remained stuck in the mud. In fact, the ratio of the price of crude oil to the price of natural gas topped 18-to-1 recently, which is a ratio we have not seen since 1990.

The spike in this ratio is due to two very simple facts: oil prices are rising, gas prices are not. The prices of these two energy sources tend to loosely track one another. But as the chart below illustrates, the prices of oil and natural gas have diverged dramatically during the last six months.

This trend has not been pleasant for natural gas producers, nor for the folks who have been investing in natural gas stocks. In this market, where nearly everything is rallying, the shares of most natural gas companies have been conspicuously sluggish. But the past is not necessarily prologue. I have not seen a better opportunity in many years to buy natural gas stocks.

Let me lay it all out for you before you click “delete” on this e-mail.

There are two reasons why natural gas prices are likely to rise from their current depressed level:

1. Natural gas exploration efforts are dropping rapidly, which will lead to a drop in supply.
2. Government initiatives will create significant new demand for natural gas.

Let’s begin by acknowledging that the price of natural gas fell because there was too much of it. We are in a recession, after all. Industrial demand for natural gas has fallen through the floor and into the basement. But the best cure for low prices is low prices.

Producers are cutting back, thereby reducing supplies. The rig count has collapsed. It has fallen much faster than in the 1981/82 collapse, the worst drop since the Great Depression, and one that still makes old-time natural gas men cringe to this day. Meanwhile, the decline rates on shale gas plays (which helped contribute so much gas to supply during the last few years) are 60-75% – meaning that the flow of gas from these wells will drop by this percentage in the first year.

Another point: The marginal cost to produce natural gas for the vast majority of natural gas companies is somewhere around $6-8 per thousand cubic feet (mcf).

Production costs are an important guide to natural gas prices, as the nearby chart illustrates. The natural gas price usually bounces off the “cash cost” of production. No producer makes money below cash costs. So supply drops. Conversely, when gas prices gravitate toward the marginal cost of production, supplies increase, thereby putting pressure on prices.

Right now, the spot price of natural gas is under $4 – sitting right on the industry’s cash costs, but well below marginal costs. In short, natural gas supply is going to start to dry up here really soon.

Meanwhile, the war on so-called greenhouse gases is officially under way. As this war progresses, clean fuels like natural gas will attract growing demand. Each passing month brings us closer to capping, taxing or cutting the gases thought to cause global warming.

I don’t think investors appreciate how far-reaching such efforts could be. And there will be definite winners and losers as a result. Some of these are far from obvious and some are in plain sight.

The first obvious big loser is American coal, from which we get half about of our electricity needs. Already, you see companies reacting to this news. Consol Energy, a big coal company, said it halted two big mines in Appalachia because of uncertainty over the costs of pending new regulations. If you own a U.S. coal miner, I’d fold the hand, so to speak.

Coal-fired power plants look like big losers, too. And the utility AEP, the biggest user of coal in North America, is looking to shutter some of its coal plants. It is also looking at how high rates would have to go to comply with possible rule changes. In some places, rates could rise as high as 50%. It is no sure thing that AEP could get such rate increases. Natural gas-fired plants, by contrast, may be one winner relative to coal. Natural gas, in general, looks to be a winner.

Beat the rush; buy your natural gas stocks now.

Source: To Do: Buy Natural Gas

–Take the Mexican stand off between BHP and Rio Tinto. BHP feels its exposure to coking coal, oil, and gas gives it an earnings advantage over Rio. Not so!, says Rio. Rio says its exposure to iron ore, copper, and aluminium means it will grow is earnings more and sooner than BHP.

–Energy earnings versus metals earnings. It kind of reminds you of the Priority Dispute between Newton and Leibniz over who invented the calculus, doesn’t it? Chicken, egg. Egg, chicken. Cluck.

–Aluminium is an energy-intensive metal, and therefore more price sensitive in an energy-scarce world. This is to Rio’s advantage, the company reckons. “The price for aluminium now has a new base,” Rio’s chief economist Vivek Tulpule told investors in Melbourne this week.

–”Margins for existing aluminium producers who have cheap energy, their own bauxite, and who aren’t exposed to the Chinese currency, go up. This is a phenomenon that people have only started to clue on to very recently.”

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–Tulpule also said that, “Though Chinese aluminium supply had traditionally risen in tandem with demand, keeping a lid on prices, soaring energy costs in China and rising bauxite costs had made Chinese producers the most expensive in the world.”

–In gold, the mantle of lowest-cost producer has always been coveted. In resource, the mantle of lowest-energy-intensity may be the key to figuring out which resources will go up the fastest. Energy-sensitive resources will see producers get hit hard by rising costs. This will cause some to close up shop, reducing production and supply. Prices will rise.

–”An energy shortage in Chile may do for copper what cuts in electricity supplies did for platinum in South Africa — spark a record-setting rally in prices,” according to Heather Walsh at Bloomberg. “Chile may be forced to limit power use for the first time since 1999 because a drought has reduced water levels at hydroelectric reservoirs.”

–Proximity and possession of energy may even better than access to cheap capital in coming years. Energy is a kind of capital, isn’t it? If that’s the case, Australia has a huge capital base, with its reserves of coal, natural gas, and uranium.

–Thermal coal prices are set to double from US$55 to US$125. That’s based on the agreement between Japan’s Chubu electric power and Xstrata which should be come the benchmark for 2000-09 contract prices. Spot prices for thermal coal have tripled in the last year. Spot coking coal (steel marking) prices have quadrupled in the last 12 months, and in the last two months they’ve doubled. Notice a pattern?

–”The value of announced cross-border acquisitions by China so far this calendar year is now US$24.5 billion from 56 deals according to Thomson Financial-already almost equaling the record of $US29.8 billion for all of 2007,” according to Colleen Ryan in the Financial Review. As usual in the financial world, the easiest way to find where asset prices are headed is to follow the money.

–”China’s acquisitions of foreign targets reached US$15 billion in the mining sector-the most active sector, largely comprising companies engaged in metals, mining, and chemicals-rising from just US$243 million in the same period last year,” Ryan writes. Are you listening BHP?

–While the great strategic game for control over Australia’s tangible resource wealth plays out here, a tawdry game of “hide the garbage assets” continues to play out in New York. “One look at the Goldman Sachs’ numbers Wednesday should tell you the credit crunch is far from over,” reports Liz Moyer at Forbes.

–”Despite the Federal Reserve’s dramatic efforts to shake loose the financial system, banks still can’t come up with accurate prices for hundreds of billions of dollars’ worth of mortgage securities, corporate loans and other assets.”

– These assets that can’t be traded and which no one wants to buy are called Level Three assets, named for the part of the balance sheet on which they reside. The banks have stuck them there the way some people might stick a crazy Aunt in the attic to avoid being embarrassed in front of the neighbours. Shut up Aunt Tilda!

–There are a lot of Aunts in the attic. “Level 3 assets now make up 13% of the $771 billion of assets Goldman holds at fair value, according to regulatory filings. Of the $96 billion, Goldman is on the hook itself for $82 billion, and that ‘economic exposure’ is up 50% from the fourth quarter.” And it’s not just Goldman.

–”The increases from the fourth quarter in Level 3 exposures weren’t as stark at Morgan Stanley or at Lehman Brothers. Morgan Stanley had $78 billion of Level 3 assets, or 17% of its assets held at fair value, up 6% from last November. Lehman had $42.5 billion in Level 3 assets, 14% of assets held at fair value, up 1% from November. The three investment banks are the first of a series of banks to file their quarterly reports detailing Level 3 exposures. The total is only expected to rise.”