A Seasonal Play on Natural Gas
08/20/2013 7:00 am EST
Natural gas prices have fallen by 25% since its April high, which in and of itself is not a big surprise, notes Andy Waldock of Commodity & Derivative Advisors.
Natural gas is notoriously volatile to the point that the market doubling or, halving in price is a common occurrence nearly every calendar year. What interests us is that the current low happens to come near the typical late-August seasonal low and also coincides with solid technical support, as well as significant buying by commercial traders. Let’s see if we can build a case for a natural gas bottom that may hold through the seasonal low run through the typical end of October seasonal peak.
Three dollars per million metric British thermal units has generally acted as good support going all the way back to the 2008 highs above $20. Rallies meanwhile seem to be stalling around $4.50. Due to the large size of the natural gas futures contract this represents a swing of $15,000 per contract from the $3 support area to the $4.50 resistance area. Therefore, if we can carve out a chunk of the next move while limiting the risk, the reward should take care of itself. The recent action is becoming indicative of a reversal since August 8 when the market made a new low at $3.129, below last July’s low and quickly rebounded to generate the first upside reversal bar we’ve seen since last September.
The fact that the natural gas market appears to be running out of new sellers as we near $3 doesn’t come as a surprise. Using the Commitment of Traders Report (COT) to measure historical trading activity can be a bit misleading, however since there have never been more participants in the futures markets than there are now. The COT report is very useful in determining the mix of market participants, though. Commercial traders in natural gas have been building a substantial long position as the market has declined and their position is now near record levels. Furthermore, short commercial traders (natural gas producers) have trimmed their negative outlook on the market and their corresponding positions by 18% in just the last week.
Seasonally, the natural gas market has a primary peak from mid-May through mid-June. The market then tends to sell off through the end of August before making a secondary peak towards the end of October. The secondary peak is usually fueled by the need to generate electricity to run the air conditioners due to late summer heat, which we’ve had very little of this year. In fact, according to the American Gas Association we’re nearly 12.5% below our average number of “cooling degree days” through August 10. In spite of the favorable climate the Energy Information Agency shows that natural gas in storage has not grown by the expected amount with reserves running roughly .5% above last year’s level.
The trade that is setting up has very little to do with the long-term price of natural gas, which should continue to decline over time. However, the combination of technical action combined with the commercial trader positions coinciding with a seasonal low definitely puts us on the lookout for some type of reversal into higher prices as we head into the fall. Considering the natural gas futures have fallen by 13% since July 18, we think that a move back towards $3.7 per million cubic feet is totally reasonable. Measuring this against current risk levels we think that it should be quite possible to find a trade risking less than $2,000 per contract and expect a reward of at least $3,500 while holding the position for a few weeks, at most.
By Andy Waldock, Founder, Commodity & Derivative Advisors