Trimming Gas: Decreasing Gas Exposure In Favour of Gold (Lee)

Trimming Gas
Decreasing Gas Exposure In Favour of Gold

by Alfred Lee, CFA, DMS, Vice President & Investment Strategist, BMO ETFs & Global Structured Investments
BMO Asset Management

February 25, 2011
Recent Developments:

  • On October 6, 2010, we issued a BMO ETF Trade Opportunity report, titled "M&ANIA", recommending our small-cap commodity ETFs as an investment opportunity given the talks of "QE2" at the time and the increased merger and acquisition (M&A) activity amongst junior commodity companies. As a result, we suggested the BMO Junior Gas Index ETF (ZJN) as one our recommended picks in that report, which has since gained 38.0%.
  • A month later, on November 5, 2010, we followed up this report with another BMO ETF Trade Opportunity report entitled "Don't Get Rolled When Investing in Natural Gas." In that report, we recommended natural gas based investments as we felt natural gas prices were not yet pricing in the seasonal decline in inventory and suggested the BMO Junior Gas Index ETF (ZJN) as a means to capitalize on this trade. Natural gas prices rallied further shortly after that report, which closed at $16.50 that day and now trades at $22.77.

Potential Investment Opportunity:

  • Given recent warmer weather patterns and with the oversupply issues of natural gas, the price of the commodity has experienced a downward trading pattern since late January 2011. The BMO Junior Gas Index ETF (ZJN) has continued to trend higher showing a growing divergence between its price and the underlying commodity.
  • Although we wouldn't be surprised to see the shares of small-cap natural gas companies move higher from here given continued M&A activity, low interest rates and growing investor risk appetite, we would advise investors to consider trimming positions. Rather than completely exiting positions, investors may want to maintain a constant dollar exposure and redeploy the capital gain portion into other positions. For example, an investor that bought $10,000 worth of ZJN on October 6, would have a position currently valued at approximately $13,800. Investors may want to consider trimming their positions back to $10,000 and reposition the $3,800 in capital gains into other investments.
  • For investors wanting to maintain some small-cap commodity exposure, we view gold as having a better risk/reward profile at this point, with bullion recently bouncing off support at US$1310/ounce on January 27, 2010. Small cap gold companies through the BMO Junior Gold Index ETF (ZJG), is an alternative for investors looking for opportunities that have a higher sensitivity to gold bullion prices. For investors wishing to maintain only an equity exposure, we recommend investors consider the BMO Dow Jones Industrial Average Index ETF (ZDJ) given both its technical strength and attractive valuations relative to other major global market indices. (Price-to-earnings ratio of 14.2x and dividend yield of 2.4%)

Chart A: Growing Divergence Between Natural Gas and Junior Gas Companies

Growing Divergence Between Natural Gas and Junior Gas Companies
Source: Bloomberg, BMO Asset Management Inc.

Chart B: Gold Prices Recently Moved Higher From Support

Gold Prices Recently Moved Higher From Support
Source: Bloomberg, BMO Asset Management Inc.

Chart C: Small Cap Gold Companies Have Higher Beta to Gold Prices

Small Cap Gold Companies Have Higher Beta to Gold Prices
Source: Bloomberg, BMO Asset Management Inc.

*All prices as of market close February 22, 2010 unless otherwise indicated.

This communication is intended for informational purposes only and is not, and should not be construed as, investment and/or tax advice to any individual. BMO ETFs are administered and managed by BMO Asset Management Inc., a portfolio manager and separate legal entity from Bank of Montreal.

Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated.

®Registered trade-mark of Bank of Montreal, used under licence.

Additional Disclaimers

The Dow Jones Industrial AverageSM is a product of Dow Jones Indexes, a licensed trade-mark of CME Group Index Services LLC ("CME"), and has been licensed for use. "Dow Jones®", "Dow Jones Industrial AverageSM", "Dow Jones Canada Titan 60" "Diamond" and "Titans" are service marks of Dow Jones Trademark Holdings, LLC ("Dow Jones") and have been licensed for use for certain purposes. BMO ETFs based on Dow Jones indexes are not sponsored, endorsed, sold or promoted by Dow Jones, CME or their respective affiliates and none of them makes any representation regarding the advisability of investing in such product(s).

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