Saturday, October 07, 2006

"Blood in the Streets" Investment Approach

This week, I bought a couple of natural gas stocks.

Natural gas prices had fallen from around $15 per MMTU late last year to under $4.5 per MMTU. Some large hedge funds had bet that natural gas prices would rise instead of fall. These hedge funds recently got into a lot of trouble and collapsed, causing them to have to "unwind" their positions.

The "unwinding" meant the hedge funds were forced to liquidate their natural gas investments. Consequently, natural gas prices fell even lower, creating a distortion - a lower price than ordinary supply and demand factors would dictate. So I took advantage of the situation and bought natural gas stocks.

This approach to investing is my favorite. It's not enough to look at the investment itself; you have to determine whether its price is out of line with supply and demand fundamentals. The stock of the fastest-growing, most profitable company in the world is a poor investment if its price already reflects these expectations. One classic approach is to look for "blood in the streets"; i.e. when everyone is panicking, creating a distortion.

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