Is the Bearish Trend Running Out of Gas?
Fundamentals
Unlike its energy complex brethren, Natural Gas futures are not seeing any benefits from a commodity market rally tied to a weak U.S. Dollar and the belief that the worst of the nearly two-year long recession is behind us. The Natural Gas futures appear to be one of the few markets trading strictly on its bearish fundamentals, with weak industrial demand and cooler than normal temperatures in the Midwest contributing to soaring gas supplies in the U.S. The most recent EIA gas storage report showed gas in storage totaled 2.443 trillion cubic feet (tcf) as of June 5th. This total is a whopping 30.3% increase to levels in storage last year, and nearly 22% ahead of the 5-year average. Last week's injection of gas into storage totaled 106 billion cubic feet, which is slightly less than average analysts' forecasts of a 110 bcf injection. This caused a bout of short-covering buying on Thursday and sent prices above the $4.00 level briefly.
That enthusiasm faded quickly at the end of the week, however, as fresh buying failed to materialize, with traders continuing to focus on weak current demand and rather strong current production levels. New sources of Natural Gas are being found, which is increasing the levels of proven reserves much more quickly than that of oil. This factor alone may be contributing to the price ratio between Natural Gas and Crude Oil widening to levels few expected. If there is one bullish factor in the great gas bear market, it is the significant decline in active U.S. gas rigs, with the current number now standing at 700, which is over half the number of rigs in operation last year. This could cause a sharp rally in prices should gas demand suddenly increase or if there is any significant shut down due to storm activity in the Gulf of Mexico in the upcoming hurricane season.
Trading Ideas
Trying to pick a bottom in the Natural Gas futures market has been very difficult, even for those with a long-term perspective, due to the wide contango the market is currently in. For those who don't know, a contango market is one where the near-term futures contracts trade at a discount to the more deferred months. The downside to this is that those traders holding long positions and then rolling out those positions to a more distant month have to pay a higher price in the deferred months. So if cash price remains steady, the futures will slowly erode down to meet the cash market as the contract moves towards delivery.
The futures options markets offer potential trade opportunities for those who may be looking for a bottom in Natural Gas futures. One such strategy would be to sell naked out-of-the-money puts in Natural Gas futures. August Natural Gas has good chart support around the 3.50 area, so a trader may wish to consider selling puts below this support point. An example of such a trade would be selling the August 3.00 puts outright. With the August futures trading at 4.061, the 3.00 puts could be sold for 0.073, or $730 each, not including commissions. The trade will be profitable if August gas is trading above 2.927 at expiration in July. The risk to this trade is if Natural Gas trades below 2.927. In that scenario, losses would total $1000 per contract for each dime the August contract trades below the 3.00 strike price, minus the premium paid.
Technicals
Looking at the daily chart for August Natural Gas, we notice the market beginning to form a symmetrical triangle formation. This is considered a consolidation pattern, with the market making lower highs but higher lows. Note that prices are trapped between the 20 and 100-day moving averages, and gas bulls would want to see the 20-day MA cross above the 100-day MA to confirm a possible change in trend. The 14-day RSI has turned neutral, with a current reading of 50.28. The last Commitment of Traders report shows large non-commercial traders (large speculators, hedge funds, etc) are still largely net-short the Natural Gas market, but they have cut back on that position significantly, as many traders do not wish to be short Natural Gas going into the Atlantic hurricane season. One just has to look at a Natural Gas chart from 2005 to see why this is the case. Support for August Natural Gas is seen at the contract lows of 3.520, with resistance found at the 100-day moving average currently around the 4.360 area.
Mike Zarembski, Senior Commodity Analyst
