Natural Gas Companies Could Benefit from 'Reshuffle'

The 'Reshuffle' Opportunity in Natural Gas

Date 02/12/2009

The Right Side

Theo Casey

Dear Reader,

Market indices are a simple way of keeping tabs on what’s happening in the market.

They provide a summary or ‘average’ view of what’s happening to a broad category of investments, for example the FTSE 100.

Every so often, the indices will ‘reshuffle’ their holdings and this reshuffle creates an investment opportunity.

You see, the FTSE 100 index reshuffle means the five (or so) smallest constituents are relegated to the FTSE 250. The five largest 250 stocks are ‘promoted’ to replace them.

The opportunity is that when stocks are introduced to, say, the FTSE 100, fund managers buy them to stay in line with their index. And that means only one thing for share prices in the affected groups. Those stocks will rise.

What’s behind this phenomenon? Index reshuffles are big business. It’s part and parcel of the way the investment management industry works today. A huge proportion of the investment industry (just under 25% of all managed funds in the UK) consists of passive and semi-passive funds that simply track the performance of an index.

This means that every time a few firms are relegated from the top tier, index funds sell off those companies. When stocks are cut from a popular index, funds have to sell these shares to continue accurately reflecting the ongoing performance of the market.

Just as those stocks that are relegated get sold, those that are promoted get bought.

Traders often look to buy those positions being promoted to profit from the likely changes in share price following a rebalance. Those in the know call this approach “index front running”. Indeed Société Générale research shows that “such a strategy has produced significant returns.”

The commodity kicker

The reshuffle effect isn’t just something for stock investors to get excited about. The same is true in the world of commodities. It’s the GSCI and DJ-UBS indexes, not the FTSE that we must look out for. These indexes rebalance only once a year, on 14 January. And there lies the opportunity…

Passive investors will follow the moves of these indexes very closely. That’s $150 billion linked to the value of those indexes according to data from Bank of America/Merrill Lynch.

Given these large sums that move in keeping with the two indexes above, expect the January rebalance to have a big impact on the market. It’s expected that copper, wheat, corn and natural gas will all be positively affected.

Each of these commodities should prosper in the reshuffle. But for the value investor, there is only one choice.

Oil’s poor relations

Which do we favour?

Gas.

Natural gas was a record cheap opportunity. It’s rallied nearly 100% from its credit crunch lows, but it’s still massively underperformed oil. Now that it’s getting a bigger slice of the index, investors are sure to buy it and bid up prices.

To buy gas, you can simply buy the ETFS Natural Gas (symbol NGAS) ETF. It provides like-for-like gains and losses with the movements in the American natural gas price. You can buy it just like a share and, unlike a futures contract, it has no set expiry.

However, our favoured gas play is BG Group. One of the most impressive statistics for BG Group is its after-tax return on capital employed, and this has remained steady in the high 20% bracket (28.7% for 2008) for several years. Even though it is now worth over £37 billion, BG is still a growth story.

The company makes £5.2 billion a year through transportable gas alone. And it has been acquiring gas assets in Australia and Asia. The company is well placed to prosper from a continuing commodity recovery and is a great takeover target.

Both directly and indirectly, gas plays are likely to benefit from the coming reshuffle effect in commodity markets.

Word to the wise – make sure to place your bets before 14 January or you may miss the move.

Best wishes,

Theo Casey
For The Right Side

P.S. Theo Casey has recently closed out a gas play for an outstanding gain in his subscription service, The Fleet Street Letter. He has since tipped a new play on gas that he believes has great potential. You can still get in now… ahead of the ‘reshuffle’. To receive this recommendation alongside the rest of Theo’s tips, click here

Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600. br>

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