One of the things that were impressed on me early in my career in the forex market was that the market can never be wrong. The market price is simply an expression of the place at which a buyer and a seller were last prepared to transact, so of course logically that is the case. Sometimes, though, when the general sentiment is negative, things get dragged down to the point where logic dictates that there is far more chance of a recovery than of further losses. That doesn’t mean that it cannot go lower, just that the odds work in favor of a buyer.
Take Golar Liquid Natural Gas (GLNG), for example.
(Click to enlarge)
The selling of natural gas futures, and therefore anything associated with the commodity, has, over the last few days, begun to look like full on panic. Yesterday, for example, the gains that resulted from news of larger than expected draw downs of gas were quickly erased and futures finished the day down once again. When even good news is shrugged off like that it is a sign that the market is acting somewhat irrationally.
That is definitely the case with a couple of associated stocks, and GLNG is the prime example. Firstly it should be noted that, in many ways, GLNG is, despite the ticker, not a natural gas stock. It is a transporter of the product.
No doubt the company’s stated aim of becoming an integrated mid-stream player in the industry has hurt it as prices have collapsed, but with the export of U.S. natural gas expected to begin early next year GLNG is placed to see significant growth.
In case you think that the possible effects of that change are being overstated, take a look at this graphic illustration of global LNG prices from the Federal Energy Regulatory Commission.
As you can see, U.S. natural gas sells for about one third of what the commodity fetches elsewhere in the world. There are some infrastructure issues that will limit the amount exported initially but given this huge disparity, strong demand for export, and therefore for Golar’s specialist tankers, is almost certain.
Now that is no secret, and as comforting as it is to put all of the collapse in GLNG down to a panicking market there are other things that have contributed. Firstly the company announced a cut in their dividend, which prompted the latest selloff. For those focused on the long term, though, that could actually be seen as a positive. More worrying is the other underlying problem.
Golar is heavily leveraged and the tightening in the high yield market that we have witnessed in the second half of this year must give some concern, even as to the continued viability of the company. It seems to me though, that as a potential early beneficiary of exports regardless of how long that may take to positively impact commodity prices, continued funding of Golar by existing creditors makes more sense than pulling the plug. It is not that that is impossible; it is just that they at least look extremely unlikely to be the first to go under. If lenders do start to panic there will be time to get out.
That is why the small bounce that we have seen in GLNG makes the stock of interest. Any break of that low of $17 gives a reasonable level to cut out of a long position, as it would indicate that there is still further to fall. Your potential loss in that case would be around 10 percent of your investment. For now, though, it looks as if a base has been formed and a recovery back to the previous support at $25 looks likely, giving a potential upside of around 45 percent.
I cannot stress enough that a trade like this demands enormous discipline. Panic is a powerful thing and if GLNG heads lower again then no matter how illogical that may seem you do not want to convince yourself that the market is wrong. Remember, it can’t be. Your view, however, can be, so taking a small loss and moving on is the only logical course of action should that happen. It is the risk/reward ratio of a trade like this that gives it appeal, but in order for that to be effective you have to be disciplined enough to limit your risk. If your stop level is never hit, however, and $25 is reached then, and only then, can you say that in this case the market actually was wrong.