High natural gas prices mean strong demand for drill rigs. More demand means higher day-rates for the rigs. That means it’s a great time to own drillers.

Q: What are your thoughts on the drillers? – J.D.

A: That’s a pretty broad question, because there are several different kinds of drillers. However, high oil prices are good for all of them…

Natural gas, for example, is the commodity of the minute. The price of natural gas rose 113% since its low of $5.25 in September 2007. That’s important because 79% of the rigs drilling in the U.S. are looking for natural gas, not oil.

High natural gas prices mean strong demand for drill rigs. More demand means higher day-rates for the rigs. That means it’s a great time to own drillers. But is it a great time to buy?

It is… if you can find ones that aren’t making new highs already. Helmerich & Payne (HP), to pick one natural gas driller, is hitting all-time highs right now. You’re paying 15 times earnings and taking on the risk of the natural gas price falling.

I wouldn’t buy HP right now. But I do think there are other opportunities. I’m researching a couple for my S&A Oil Report subscribers right now.

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Q: What do you think of all the protests against high gas prices? – R.T.

A: In my introductory biology class at Penn State, my professor told us a story…

Some years ago, in central Pennsylvania, there was an abundance of rain, and the clover grew thick. Lots of clover meant the rabbits had plenty to eat. Happy rabbits did what rabbits do… and pretty soon, the place was overrun with rabbits.

Lots of rabbits meant the foxes had plenty to eat. They got fat and sleek. They also made lots of baby foxes. But after a while, those rabbits ate all the extra clover. That meant they weren’t making more rabbits quite as fast as before. Fewer bunnies meant more hungry foxes.

Eventually some of those foxes starved.

In terms of oil, we’ve run out of clover – big, easy-to-find, easy-to-pump deposits. So refining companies (the rabbits in our story) are hurting. There is too much competition for too few resources. Now the airlines, truckers, and SUV drivers (our foxes) are getting hungry.

The world’s demand for fuel is catching up with an industry that really hasn’t changed much since the 1970s. Oil and gas prices must respond to market forces (and go up) to make us change. The protests are simply the whimpers of starving foxes.

Note: I got loads of responses to my request for more gold funds…

The big one you mentioned was the Central Fund of Canada (CEF). This $1.5 billion fund holds gold and silver bullion. Currently, shares trade nearly 9% above the value of the fund’s assets. That means you’re paying $90 more than you need to on every $1,000 you invest in the stock.

That’s fairly unusual among gold funds. The largest of them all, GLD, trades at a 0.42% premium to its assets. IAU trades at a 0.16% discount to its net asset value. If you are just trying to buy gold, find a fund that is liquid and trades close to its net asset value.

Another mixed fund is the Gabelli Global Gold, Natural Resources, and Income trust (GGN). The fund focuses on global natural resource and mining stocks. So it isn’t a pure play on gold. This fund’s largest holding is actually Petrobras, the Brazilian oil company. It’s trading at nearly an 8.5% discount to the value of its assets and it uses creative financial strategies (selling covered calls) to generate a 5.8% yield.

Finally, you’ve got Deutsche Bank’s Double Short (DZZ) and Double Long (DGP) Exchange Traded Notes. These two funds use gold futures and treasury notes to return twice the fall or twice the rise of gold, respectively. These funds are extremely risky, since they double the performance of the metal. You shouldn’t ever invest more money than you can afford to lose into this type of fund.

Good investing,

Matt

P.S. If you’ve got a question about commodities or commodity producers, shoot me an e-mail. (Bear in mind, I can’t give out personalized investment advice.) I answer reader questions every Wednesday in Growth Stock Wire.

Source: The Commodity Investor Q&A Wednesday, June 4, 2008