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Oil vs. Natural Gas: Something Has to Give

CNBC.com

The price of oil has always been front and center for market watchers, but it is now watched as closely as ever.

There are a variety of reasons for this.

One is oil’s wild ride last year.

It rocketed all the way up to $147.50 a barrel last June before plummeting down to $33 in January/February of this year. (At that time, Russian government sources told me the government there was making budget plans assuming that oil would hit $20 a barrel.)

Another reason is the fact that demand for oil simply has to pick up if and when the global economy resumes growth.

Supply and demand are the most important factors in determining the price of anything, but Dan Niles, Co-Chief Investment Officer at Alpha One Capital Partners, is closely watching another way to view oil prices, and that is their relationship to natural gas.

As Dan recently emailed me, oil has historically traded at 8x to 10x the price of natural gas.

One of the reasons it usually stays within that range is the law of physics: On a thermal basis, it takes roughly six times the amount of oil to generate the same amount of heat as natural gas.

Looking at today’s prices, however, oil is going for a hefty 17x the price of natural gas, far outside the historical norm.

What does this mean?

Either oil is overvalued right now, or natural gas is incredibly cheap. Dan told me he believes that oil will get crushed or natural gas will go up a lot over the next year “because the laws of physics do not change.”

It will be interesting to see what happens.

I’m hearing a lot of talk that oil has more room to fall, at least in the short term.

If a global recovery gets under way in earnest later this year or early in 2010, however, I wouldn’t be surprised to see prices increase.

Dan is primarily a technology investor, but recently he has been investing in the “inflation trade,” buying commodities producers on the bet that international economies will see increased demand in all sorts of raw materials and resources such as aluminum, copper, iron ore, steel, and oil among others.

You can watch my latest interview with Dan, and you’ll be hearing a lot more from him in the coming months.

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Questions? Comments? Write toinvestoragenda@cnbc.com

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