Below is an excerpt from our most recent Newsletter. To receive access to this story, with trade strategies, and our daily coverage of 16 markets, visit futures-research.com for your free 2 week trial!
In many ways the natural gas market sits in classically bearish fundamental position. US storage levels are nearly at capacity, industrial demand is expected to remain soft, and the threat against supply from the current hurricane season has so far been the lowest in over five years. However, we would suggest that the natural gas market is fully aware of its bearish fundamentals and that they were already priced into the market when prices fell to the September low of $3.49.
While a number of physical commodities like crude oil, copper, sugar and cocoa have already begun to factor in some form of economic recovery, one could suggest that natural gas prices have no such improvement priced into their equation. And while we still haven’t seen the “seminal” development that would indicate that a change is underway, we do think that the economic process is set to prompt a bottoming in prices. In addition to prices reaching the lowest level in seven years, the differential between natural gas and crude oil is trending back toward the extreme again, and that in conjunction with increased lobbying efforts from the gas industry might result in some governmental favor ahead.
In looking back at the speculator activity over the last year, one sees that a massive net short position was built into natural gas as petroleum prices were making historic highs. That might suggest that players were simply hedging long crude oil plays with short natural gas positions. In fact, in the wake of the major energy top in 2008, open interest in natural gas fell from a peak of 976,609 contracts just after the top to only 619,499 this past March. It should also be noted that the low point in natural gas open interest was seen in relative proximity to the major low in crude oil prices. This all seems to suggest that the trade has consistently used the natural gas market as a hedge against the desire to be long crude oil.
On the other hand, it would appear that a large portion of the sellers in natural gas during the sub-prime crisis were picking natural gas as the market most likely to suffer demand losses due to a sustained recession. As can been seen in a COT positioning chart, speculators built a historic short position in natural gas into the peak of the sub-prime disaster, apparently off of ideas that industrial demand for natural gas was set to decline. Given that demand did decline and storage levels exploded, the march to new lows over the last nine months was clearly justified.
While the jury remains out on the prospect of a recovery in the manufacturing sector, we would suggest that demand shouldn’t be as bad as was assumed into the summer of 2008. Certainly the natural gas market saw the net spec short position eradicated after a depression was avoided. Last March the market was even able to build a net spec long of 27,641 contracts.
In short, we think the market has moved back into a more normal economic and technical posture, with the speculative interest thought to the under scrutiny in the crude oil market, the prospect of gradually improving demand and the potential for political change on the rise. With their net position returning to at net short in excess of 40,000, the specs are leaning heavily to the bear side, but the case lower prices seems to be dissipating. However, because the fundamentals remain questionable, traders need to use strategies that compensate for lingering weakness in prices in the coming weeks. For instance, they could consider credit call spreads or long calendar call plays.
