Chasing These Markets Higher Will Prove Very Risky

Short-term and long-term weather forecasts continued to weigh on December Natural Gas futures this week, despite a slightly bullish inventory report from the U.S. Energy Information Administration (EIA). With the November through March heating season rapidly approaching, traders are beginning to track winter weather forecasts more closely since this is the peak demand period for U.S. gas consumption.

This week, natural gas prices fell to a three-year low, however, there were some signs of aggressive speculative buying early Thursday after the EIA reported that natural gas supplies rose less than expected last week.

According to the EIA, weekly natural gas storage in the U.S. in the week-ended October 16 rose by 81 billion cubic feet. This was below expectations for an increase of 88 billion.

Additionally, it was also below recent builds of 100 billion cubic feet the week-ended October 9 and 94 billion cubic feet in the same week last year. The five-year average change for the week is an increase of 84 billion cubic feet.

Currently, stockpiles sit at 3.814 trillion cubic feet. Last year, stocks stood at 3.380 trillion cubic feet. Stockpiles are also 163 billion cubic feet above the five-year average of 3.651 trillion cubic feet for this time of year.

The bigger inventory picture shows that stockpiles could reach a record by the end of the month. According to the EIA, storage levels are expected to peak at 3.956 trillion in November. This would put it above the November 2012 high at 3.929 trillion. 

Prices have tumbled during this year's injection season (the period from the end-of-summer to the end-of-October). And this week's price action suggests prices could fall even further since it doesn't look like there is going to be much heating demand over the near-term. This means that stockpiles should continue to build longer than normal this year, pushing the already oversupplied inventory into a deeper glut and prices into multi-year lows.

The price action on Thursday epitomizes the price action that could be expected over the near-term. This means that even with bullish news, hedgers will be waiting to sell rallies.

Heating demand is expected to remain low over the short-run because much of the U.S. is expected to experience seasonally warmer temperatures over the next week. Earlier in the week, prices firmed because of predictions of cold temperatures, however, the cold weather system never developed, sending prices plunging. Forecasts are now calling for above-normal temperatures over key demand areas next week and normal conditions into November.

The weather outlook for beyond November suggests a range bound market at best if the El Nino weather system materializes as predicted. The El Nino pattern is expected to bring warmer temperatures to the Midwest, leading to forecasts of lower demand for natural gas.

Other than a few short-covering rallies due to technically oversold conditions, natural gas prices are expected to remain under pressure well into November. The EIA forecast for storage levels to peak at 3.956 trillion in November or at a two-year high, coupled with the above average temperatures should keep a lid on any rallies. 

December Heating Oil futures are also expected to remain under pressure due to oversupply and bearish weather forecasts.

Technically, the market is in a down trend on the weekly chart and buyers would have to take out $1.7386 with conviction in order to generate any interest on the upside. Realistically, a breakout over this level would likely be triggered by short-covering anyway.

Holding above $1.4272 could help aggressive speculators build a case for a potentially bullish double-bottom, but this may only encourage enough buying to bring heating oil back to the retracement zone at $1.5462 to $1.5829.

The fundamental news is bearish also. Recent supply and demand data shows that inventories of distillate fuel oil in the East Coast are higher now than they have been in the previous three years.

Summary

The bearish supply glut in both natural gas and heating oil should continue to exert downside pressure on both markets. Lower-than-normal demand should also contribute to the selling pressure. Demand is expected to remain low because of unseasonably warmer temperatures into mid-November. This could actually extend into December if the El Nino phenomena begins to take effect.

Any rallies are likely to be fueled by short-covering and are likely to be met by renewed selling. It is going to take time to develop a well-structured bottom so contrary traders shouldn't speculate on the long side unless they can buy at extremely favorable prices. Chasing the markets higher will also be risky. Based on current conditions, shorting price spikes seems to be the best way to approach these markets at this time.