Natural Gas Bear Market on its Last Legs?
Today's Idea
Some traders looking to go long Natural Gas may wish to consider exploring long option strategies going out to the late summer or early fall trading months, when the hurricane season is at its peak. Given that Natural Gas options are rather expensive, especially during the storm season, some traders may wish to explore the purchase of bull call spreads in Natural Gas futures options. For example with October Natural Gas trading at 4.721 as of this writing, the October 4.80 calls could be bought and the October 5.80 calls sold for about 0.280, or $2,810 per spread, not including commissions. The premium paid would be the maximum potential risk on the trade, which has a potential gain of $10,000 minus the premium paid which would be realized at option expiration in late September should the October futures be trading above 5.800.
Fundamentals
Natural Gas bears have feasted on the bulls for nearly three years, as prices have fallen sharply since the highs were made back in July of 2008. However, it appears that prices may have finally stopped declining, but is this really the beginning of a new bull phase or a basing period where prices may consolidate in a relatively tight range? U.S. Natural Gas inventories are down 11% from year ago levels, standing at 1.685 trillion cubic feet (tcf) as of April 22nd. The weekly EIA gas storage report showed a build of only 31 billion cubic feet (bcf), which is well below the pre-report estimate of a 37 bcf build. By comparison, last year at this time, we saw a build of 81 bcf. The larger declines in storage this year compared to last can be partially attributed to the much colder than normal winter in the U.S., which increased gas consumption for heating. Lower cash prices for Natural Gas have finally caused producers to curtail drilling. The widely watched U.S. rig count from Baker Hughes showed that the U.S. gas rig count fell to 878 this past week. This was nearly 10% lower than last year. Canadian gas rig counts also declined, as oil and gas producers are turning their focus back to oil, which at its current price of over $110 per barrel is a much more profitable venture. The fact that we are seeing some increases in demand at the same time production is being curtailed is a key ingredient in the possible formation of a bull market. The final catalyst may be found in the Commitment of Traders report. Here we see that large non-commercial traders are holding a relatively large net-short position in Natural Gas futures, totaling 177,325 contracts as of April 19th. Though far from a record short position, this large position may be liquidated should prices begin to move higher, or should we see production issues come late summer and early fall during the peak Atlantic hurricane season.
Technical Notes
Looking at the daily chart for June Natural Gas futures, we notice prices breaking-out to the upside, out of the symmetrical triangle formation. The break-out also occurred on much higher than average volume, which gives further validity to the upside move. Prices have now moved above the important 200-day moving average that many longer-term traders use to determine if a market is bullish or bearish. The 14-day RSI has turned positive, with a current reading of 64.87. The next major upside hurdle for the June Gas futures is the yearly high made back in January of 4.850. Support is found at the 20-day moving average, currently near the 4.320 area.
Mike Zarembski, Senior Commodity Analyst
