Why Natural Gas is Overdue for a Bounce
- Jun 29, 2020
When approaching any market, the risk-reward of a long or short position is a critical factor. In the world of commodities, the supply and demand equation can dictate the top or bottom end of a pricing cycle. Natural gas is one of the most volatile commodities that trade on the futures markets. Wide price variance tends to attract speculators that look for price trends. The old saying goes, the trend is your best friend in markets until it bends.
Since early May, the trend in the July natural gas futures market on NYMEX has been lower. After rallying to a high of $2.162 on May 5, continuous contract futures continued to decline. Natural gas is now at a price level where risk-reward favors the upside during the hot summer months.
There are plenty of speculative bears in natural gas these days as the price action and trend have made every attempt at a recovery a selling opportunity. However, natural gas has a habit of turning on a dime, and we could be close to an inflection point on the downside in the energy commodity. The United States Natural Gas Fund (UNG) follows the price of natural gas futures on NYMEX higher and lower.
Last week, the July futures contract in the natural gas market rolled to August. Before expiring, July futures put in a fresh twenty-five-year low.
As the weekly chart highlights, the price fell to a low of $1.4342 per MMBtu, a level not seen since 1995. Price momentum and relative strength indicators were falling towards oversold conditions at the end of last week. Open interest, the total number of long and short positions in the natural gas futures market has been rising over the past weeks. The metric moved from below 1.2 million to the 1.317 million contract level at the end of last week. Rising open interest and falling prices tend to be a technical validation of a bearish trend in a futures market. Weekly historical volatility at just below 50% was at the highest level since mid-May. Active month August futures settled at $1.544 per MMBtu on Friday, June 26.
Cooling demand is about to peak, and output is falling
According to Baker Hughes, 75 natural gas rigs were operating in the United States at the end of last week. While the number was unchanged from the previous week, it was 98 lower than the 173 rigs in operation at the end of June in 2019.
In a sign that demand has declined, the EIA reported a higher than expected 120 billion cubic feet injection of natural gas into storage for the week ending on June 19. The lower number of rigs and rising stockpiles, which recently moved over the three trillion cubic feet level, is a sign of weak demand. As we head into the warmest months of the year in the US, demand for air-conditioning should increase. The current average consensus estimates for injection into storage for the week ending on June 26 is around the 75 bcf level. The stage could be set for a recovery rally now that natural gas put in another in a long series of lower lows since March.
The all-time bottom in the natural gas futures market came just two years after trading on NYMEX started in 1990. In 1992, the price fell to a low of $1.02 per MMBtu. As we learned from the oil market in April, new record lows are a possibility. Before a test of the 1992 low, natural gas has two levels of technical support on the long-term chart.
The quarterly chart shows that the energy commodity fell to a low of $1.335 per MMBtu during the second half of 1995 and a low of $1.25 during the first half of the same year.
Natural gas is overdue for a bounce to the upside, but speculative shorts are pushing the price lower in an environment of weak demand. The natural gas market has traded in a range from $1.02 to $15.65 per MMBtu over the past three decades. At below the $1.50 level, risk-reward continues to favor a recovery, but the trend remains bearish. I would only approach natural gas from the long side at the current price level, but a tight stop is necessary because fighting a trend to pick a bottom can be challenging in any market.
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The United States Natural Gas Fund L.P. (UNG) was trading at $10.02 per share on Monday afternoon, up $0.97 (+10.72%). Year-to-date, UNG has declined -40.57%, versus a -4.65% rise in the benchmark S&P 500 index during the same period.
UNG currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #69 of 112 ETFs in the Commodity ETFs category.
Andy spent nearly 35 years on Wall Street and is a sought-after commodity and futures trader, an options expert and analyst. In addition to working with StockNews, he is a top ranked author on Seeking Alpha. Learn more about Andy’s background, along with links to his most recent articles. More…