What Can a Fund Tell Traders About Natural Gas?

05/12/2010 12:01 am EST

Focus: COMMODITIES

Generally speaking, all is not well in the natural gas market these days, at least according to the charts for natural gas futures and natural gas-related equities. Sure, there was a brief rebound after 2008's epic decline from nearly $13.70, but as of this writing, the front-month contract for natural gas is just a scare above $4.00, hardly an encouraging sign for energy bulls. Prices for stocks of natural gas-industry companies have fared slightly better, but they too are still down more than 50% from the lofty highs achieved during July 2008. Last week's vicious selloff in the broad equities market also took aim at these particular stocks, causing a major breach of weekly support that may give us a fairly good target price for the next support level. If you're a natural gas stock bear, take heart, because you may have a fairly low-risk short setup in the making.


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Figure 1. Keltner bands can be wonderful support/resistance tools, and are especially useful for option traders. On this chart, note how the next lower Keltner band combines with a prior swing low to form a potential support level near $22.50.

Above is the weekly chart for the Fidelity Select Natural Gas Fund (FSNGX). This is a bare-bones chart, one overlaid with two Keltner band grids set at 4.2 and 7.5 standard deviations (respectively) away from a 45-week exponential moving average (EMA)(also known as the Keltner midline). These two Keltner band settings will help to identify an inordinate number of support/resistance levels in nearly every freely traded market and should be considered as key early warning technical tools for serious traders of every persuasion. In particular, they work exceptionally well for option traders in the futures and equity markets. I've used them in numerous real-world option sale trades, and they are nothing short of amazing.

Anyway, on this weekly graph for FSNGX, the most obvious feature is the sharp breakdown from the Keltner midline this past week (Figure 1). Given the wide-range weekly bar, this appears to be a valid breakdown, causing forward-thinking traders to consider the next major weekly support level in this fund. In July 2009, FSNGX made a solid low at $22.97 before gradually grinding higher to $34.29 in late-October 2009 and turning lower at the next higher Keltner band, as it so happens. When this fund embarks on a trend, it usually does so in style, as that three-and-a-half month jaunt higher certainly proves. It was good for a 48% gain, after all.

If you have a Keltner-based worldview of the markets, as I do, that key support area near $22.97 to $22.23 looks to be acting like a major attractive force to FSNGX, meaning that a decline to say, even, $23.00 would lop more than $5.00 a share from the NAV for this fund. No, you can't short FSNGX (it's a long-only fund, as are all Select Sector funds), but there are plenty of ETF proxies for the natural gas equity group, such as First Trust ISE - Revere Natural Gas Index Fund (FCG). FCG closed at $16.39 and has a minor support level at $15.50 and then a stronger support at $13.89. This fund looks extremely vulnerable here, so you may want to investigate the potential for buying put options (at the money preferred, with at least two months till expiration) in anticipation for a fast run lower to the sub-$14 zone.


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FIGURE 2. LOWEST FIVE. Energy-related funds hold down the lower five slots in the 40-fund Select Sector fund universe.

Finally, note the weakness across the entire energy sector, which happens to hold the lowest five slots out of the 40 funds tracked. Get ready for another “interesting” week in the stock and commodities markets!

By Donald W. Pendergast, Jr. of ChartW59.com

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