Will Short-Covering "Fuel" a Rally in Natural Gas Futures?
Fundamentals
The old saying "every dog has its day" has been quite apropos for the Natural Gas futures market during the past week, as the market staged a significant rally since the lows of 3.227 in the August contract were made on July 13th. Much of the rally was attributed to short-covering by speculators, as better then expected corporate earnings and signs of improving economic data have traders starting to look forward, expecting demand to begin to improve. However, in the near-term, the U.S. still has more than ample supplies of Natural Gas in storage. As of July 10th, Gas in storage totaled 2.886 trillion cubic feet (tcf), up 18.7% from the 5-year average of 2.432 tcf. Mild summer weather in the Midwest and Northeast has lessened the demand for air conditioning, which curtails the demand for power production. In addition, there have still not been any definitive signs that industrial demand is turning up, as the EIA predicts industrial demand to be down by 8.2% in 2009. Gas producers are trying to respond to slack demand by curtailing drilling for Natural Gas. It is estimated that rig counts are down nearly 60% from the end of the third quarter of 2008. As we move closer to the peak hurricane season in the Atlantic starting in September, we may begin to see traders start to price in a weather "risk premium" in the fall month contracts, as any significant storm damage to the energy infrastructure in the Gulf of Mexico could curtail production for some time and send prices higher as the current gas" surplus" is absorbed. However, early in the season we are already seeing some forecasters predict fewer storms this year -- most recently; WSI Corporation lowered their estimate to 10 named storms down from 11 they earlier predicted. WSI also lowered the number of storms expected to reach hurricane strength to 5, down from the 6 storms earlier predicted. Although it appears that Natural Gas bears continue to hold the upper hand given current Gas fundamentals, traders should not become complacent with the current lack of volatility the Natural Gas market is presently experiencing -- especially with a large net-short position still being held by large speculative traders. This short position could be the fuel for a sharp move up in prices should any supply disruptions occur.
Trading Ideas
With Natural Gas prices at relatively low price levels as we head into the heart of the hurricane season, the odds of a "weather premium" being built into the fall month contracts increases. One way a trader may wish to play this scenario is to investigate bull call spreads in the fall month contracts. An example of this trade is buying the November 5 calls and selling the November 7 calls. The November options expire in the last week of October, which is nearly the end of the peak hurricane season. With November Natural Gas trading at 4.560, the spread could be purchased for about 360 points, or $3600 per spread before commissions. More aggressive traders may possibly wish to sell puts below the current contract lows of 4.25 to help offset some of the long premium cost of the bull call spread. An example would be selling the 3.80 puts for November, which could be sold for about 240 points or $2400 per option currently. Traders considering this strategy should remember that when selling these puts you are potentially increasing the downside risk of this trade and so should have an exit strategy in place in the event the November Gas moves below support at the 4.250 level.
Technicals
Looking at the daily chart for September Natural Gas, we notice prices once again failed to take-out the 100-day moving average. This is important for Natural Gas bulls, as many technical traders will not consider a market to be bullish unless prices are above the 100-day MA. The 14-day RSI is turning weak, with a current reading of 43.07. 3.366 remains support for the September contract, with resistance found at last week's highs of 4.045.
Mike Zarembski, Senior Commodity Analyst
