Equity Strategy September 29, 2006 :

If you have been watching CNBC you would think that the entire world is holding their collective breath in anticipation of the Dow Jones Industrial Average finally getting back to its all time high of 11,722.98. CNBC has touted this potential event daily all week and the Dow has failed to make the move.

Remember that the old high was set on January 14 th 2000 or more than six and a half years ago! In the daily comments today by David Rosenberg, Chief Economist at Merrill Lynch, only 2 of the 30 Dow stocks American Express and Proctor & Gamble have managed to reach new highs since January 2000.The average Dow stock is still down 34% from the record high. Mr. Rosenberg also states that if inflation is taken into account the Dow still has 14% to go to get back to the previous high.

It is funny that the stocks that have done well over the past 6.5 years are mainly companies that CNBC does not talk about because they tend to be in the “old economy” industrial and consumer sectors. These companies do not have the rock star style CEO's like Richard Branson or Larry Ellison that dominated the Tech bubble they have CEO's that just quietly go about running the business.

One interesting strategy that seems to work is to buy companies that are never mentioned on CNBC and sell the companies that are touted on this channel. This is a kin to the theory of the Front cover of Time, which basically says that the poor guy who ends up on the front cover of Time magazine has nearly a 100% chance of sliding in to oblivion shortly after the issue comes out. The cover has been an excellent contrarian indicator of what is about to become old news.

It seems as though natural gas is on a one way street these days and there aren't any stop lights either to slow the pace of the long decline. The lack of increased demand over the summer due to cooler than normal temperatures has created a surplus of natural gas in North America . The excess supply has forced prices down to levels not seen in almost four years.

The spike in price last year around this time came on the heels of hurricane Katrina which caused substantial damage to the production infrastructure in the Gulf of Mexico . The run up in price was exacerbated by the flood of speculators who jumped into the market and pushed the prices well past the fundamental value.

The amount of spec money in the gas market is underscored by the huge $6 billion hit that Amaranth Capital Advisors took being on the wrong side of the market. The energy markets needed a good blow up to push the excess of speculative money out of the market.

Once the rebuilding began after Katrina it soon became clear that the gulf would be back in production much sooner than forecast and the buying turned in to selling in a hurry. It has been a steady decline from the highs to the current level. The fundamentals have not yet turned positive and will not show a marked improvement until we get well into winter.

Natural gas is being increasingly used as the fuel of choice by electrical utilities as a cleaner alternative to coal. The use of natural gas has also been increasing as the main fuel source for home heating as an alternative to heating oil and electricity. The US economy uses approximately 3 times as much natural gas for heating as it does for cooling. The winter is definitely the season of demand for natural gas.

The coming winter is forecast to be warmer than normal, but then the current hurricane season has been forecast to be one of the worst in recent history and so far that hasn't been the case. If North America has a normal winter there will be a marked increase in the demand for gas for electricity and to heat homes this will reduce the surplus and should push the price higher.

Looking at the shares of natural gas producers it would seem that the market expects gas to continue to fall a lot further. In the energy trust sector natural gas focused trusts have seen a dramatic decline in price along with the commodity. There are going to be a number of these trusts that will be forced to cut the distribution to unit holders as they are not going to be able to generate enough cash flow to support the current payout.

The reduction in distribution is being anticipated and the prices have fallen as a result many of the current prices envision a cut of 50% or more from current levels. A lot of the risk in owning these companies has already been discounted in the market offering investors an opportunity to enter this sector with a reasonable risk level relative to earlier this year.

There are three natural gas focused trusts that have seen a substantial price decline and now offer an opportunity for investors willing to accept the risk of volatility related to the potential for a distribution cut.

Advantage Energy Income Fund (AVN.UN-T) 70% of the production is natural gas the balance in oil reached a high of $24.25 in February and has seen a steady slide since. Advantage reduced the distribution in July to 20 cents per unit per month down from 25 cents and will likely have to reduce the distributions again before the end of the year.

Over the past 12 months the distributions have totaled $2.85 per unit, if one assumes that the distribution will eventually be cut in half that would forecast a reduction to $1.425 and would still offer investors a yield of 10.4%. The reduced yield would still offer a reasonable return while waiting for the price of natural gas to recover.

Trilogy Energy Trust (TET.UN-T) with natural gas accounting for 80% of total production reached a high of $28.50 in October 2005 during the surge in energy prices caused by hurricane Katrina.

Over the past 12 months Trilogy has paid a $2.75 distribution to unit holders. The distribution has been reduced once in May of this year from 25 cents per unit per month to 20 cents. Again if the distribution is forecast to be cut in half from last year then Trilogy would pay $1.375 annually. This reduced distribution would still offer an 8.5% yield at the current price, an attractive return when combined with the potential for capital appreciation as natural gas rebounds.

True Energy Trust (TUI.UN-T) 62% of total production is natural gas, 25% heavy oil and 10% light oil reached a high in late September 2005 of $23.90 as the natural gas surged.

Distributions fro the past 12 months total $3.00 and have remained stable at24 cents per unit per month since the beginning of the year. If the company is forced to reduce distributions by 50% to $1.50 annualized the yield on this lower payout would still be 13.5% at the current market price.

These beaten down energy trusts offer a opportunity for those who are willing to accept the uncertainty and volatility of the energy markets over the next 12-18 months. In the main the market has already priced these securities for a substantial distribution cut reducing the down side risk considerably.