Natural Gas Analysis for the Week of March 26, 2012

Last week looked promising for May Natural Gas following the previous week’s closing price reversal bottom, but even after a confirmation, the market could not follow-through to the upside.

Early in the week, the market took out 2.468 to confirm the closing price reversal bottom at 2.306, but sellers came in at 2.502, slightly ahead of downtrending Gann angle resistance at 2.524. The inability to gather enough buying power to push through this price forced the market to turn sellers, driving natural gas lower for the week.

Before getting too excited from what is merely short-covering, a closing price reversal bottom does not mean a change in trend has occurred. It usually means that the market has run out of sellers, giving established shorts an excuse to take profits and wait for an opportunity to refresh their positions.

As long as the reversal bottom at 2.306 remains intact, natural gas still has a chance to breakout to the upside. This week the key area to watch is downtrending Gann angle resistance at 2.444. A breakout through this price is likely to mean the market is headed toward a minor 50 to 61.8 retracement zone at 2.661 to 2.744. If this short-covering rally doesn’t materialize and the market takes out 2.306 then look for an acceleration to the downside.

Despite the overwhelmingly bearish fundamentals, natural gas has had trouble breaking out of the 2.20 to 2.40 range. This may be because traders have turned their attention to crude oil because of the volatility. Even though natural gas has a clearly defined trend, without the volatility, short-term traders are going to move to a market that is more active. In addition, some traders feel that the move has run its course after hovering around 10-year lows and are waiting for a meaningful retracement to short.

Fundamentally, bearish traders couldn’t have asked for a more promising scenario as output rose in conjunction with falling demand. Spring greeted the market with several days of above-normal temperatures. This triggered a drop in demand at a time when the government was releasing a weekly report that showed that producers were putting gas into storage. This last action broke a 5-year trend whereby demand had been outstripping supply at this time of year.

Last Thursday the Energy Information Administration released its weekly inventory report which showed inventories ended the winter season 54 percent above the five-year average. Since we are now entering the season where demand traditionally falls while production rises, bloated stockpiles are likely to be around until the summer when air-conditioning season begins.

Later in the week drilling services company Baker Hughes Inc. reported that the number of working gas rigs fell by 11 last week to 652 and was down by 228 from a year ago. This was the lowest level since May 2002. Even though the number of gas rigs has been dropping steadily, averaging 13 each week since November 2011, it hasn’t really affected production.

Traders are now looking for this figure to accelerate as prices continue to fall. The drop in the rig count has had virtually no affect on prices because about a third of the gas being produced is coming from crude oil drilling sites. These producers consider the gas they are obtaining as a way to offset the cost of drilling for oil and don’t seem to mind the low prices.

Although the fundamentals suggest lower prices, short-covering may drive the market higher over the short-term. This move will be more technical in nature due to the closing price reversal bottom formed two weeks ago. Traders should not read this as a change in trend or a short-term buying opportunity. It is most likely going to be an opportunity to refresh short positions at higher price levels. The key price level to watch is 2.444. Bearish traders may defend this level early in the week, but a breakout above this price could mean the start of a 2 to 3 week rally.

Factors Affecting Natural Gas This Week:

Weather:  Since winter is over in the U.S., the focus is not going to be on the weather until air conditioning season drives up demand for electricity. Since winter was mild and spring has started out with higher-than-normal temperatures, traders should watch for the possibility of an early summer.

Supply and Demand:  The heating season ended with demand falling and supply rising. Since spring has arrived and nothing has been done to curtail production, look for natural gas inventories to swell until the summer cooling season begins.

Chart Pattern:  The fundamentals are bearish but the chart pattern suggests bottoming action due to oversold conditions. The closing price reversal bottom from two weeks ago at 2.306 is still holding so natural gas is still in a position to work its way higher. If this low fails as support then look for a sharp break.

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