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Commodity Stocks Are on the Brink of Disaster

Investors in natural gas stocks have lost their minds and are about to lose their wallets.

There's a major wipe-out coming in the natural gas business. North America has too many natural gas producers. The industry needs a major cleaning out. The most inefficient, high-cost producers must fold. This will bring supply and demand back into balance. Low prices are the market's mechanism for culling the weak players.

Four weeks ago, natural gas prices hit a seven-year low of $2.50 per thousand cubic feet. But so far, nothing's happened. No player wants to cut production when they've invested so much money developing it. "Getting $3 is better than nothing," they think. "Better to pump out more now before it falls even farther."

In the last four weeks, gas has jumped above $4 and is closing in on $5. With higher prices, production is growing. According to industry researcher Baker Hughes, the number of rigs drilling for natural gas in the United States has gained in nine of the last 10 weeks. Meanwhile, the oversupply of gas is so great, we've almost run out of room to store it.

The Energy Information Administration says U.S. natural gas inventories rose again last week. They are now a just a chip shot from the record high hit in November 2007. Natural gas storage in producing regions – including Texas, Louisiana, and Oklahoma – already reached a record high last month.

Aubrey McClendon, CEO of Chesapeake Energy, the largest independent gas producer in America, figures America's natural gas industry will fill up all available storage by the end of the year. There'll be "involuntary curtailments," he says.

In the last two years, the price of natural gas has fallen almost 70%, yet natural gas stocks are still trading at almost the same prices. In other words, investors in natural gas stocks have totally ignored the huge collapse in natural gas prices.

And get this...

Natural gas stocks have thrashed oil stocks over the last nine months, even though the price of oil gained 60% over this time, while the price of natural gas lost 13%.

The guillotine is about to fall on natural gas production. And I can't see any reason for this strength in natural gas stocks. My only conclusion: Investors in natural gas stocks are living in la-la land. The dream ends when storage runs out or gas prices fall back down again.