Is Natural Gas Set To Plunge Again?

With crude stuck in a range for a month or so, my attention has increasingly been on natural gas. That is unusual for me. Anything that moves in big chunks in response to something as unpredictable and unreliable as the weather forecast has always seemed to me to be more of a casino bet than a trade. Still, movement equals money for a trader and without any in WTI futures, natty's crazy swings have started to look a bit more attractive.

Despite the weather thing, I have found that natural gas does have a couple of redeeming features as a trading instrument. It tends to sustain momentum and often respects simple technical levels such as basic support and resistance or channels.

That is of particular interest right now, because we have seen two days of trading lower, and the reversal of a couple of days ago represents a failure to break above the previous high. In other words, the technical picture looks pretty bearish.

The real appeal of a short here though is that the fundamental factors point the same way. Gas has an oversupply problem. The advances in fracking and the development of shale fields have had a massive effect on oil, of course, but one could argue that those and other technological advances that have increased the ability to capture gas have had even more of an impact on natty.

After all, U.S. production has nearly doubled since 2005…

Figure 1: U.S. Natural Gas Production. Source: eia.gov

To be fair, demand for the fuel has also increased substantially as more and more power stations have switched from other less environmentally friendly fuels to relatively clean natural gas. Actually though, although the environmental concerns are usually the stated reason for those changes there is another one. Gas is cheap. The price has collapsed as production has increased over the last fifteen years.

You are all smart people, so I'm sure many of you are reading the above and thinking "Okay, but what does a fifteen-year trend have to do with a trade that will last at most a week or two?" Well, the answer is that while a long term trend like that doesn't negate the possibility of a tradeable move in the other direction, it does mean that moves with the trend have more chance of being sustained and that moves in the opposite direction have more chance of petering out quite quickly.

Those long-term factors do matter, but a trade still needs a short-term catalyst and there is one for natural gas. Yesterday's EIA Storage Report, that covers the week ending on 7/24, showed yet another build in inventory. That suggests that gas is still being produced in large quantities, even as the economic outlook in the U.S. worsens.

There was a slew of bad, no terrible, economic data this week. We learned that GDP contracted by roughly one third in Q2, for example. That was somewhat expected, but the number is still shocking. More worryingly, both the weekly unemployment claims and continuing claims increased, suggesting that far from recovering, the real U.S. economy is sliding even further into the abyss.

I know that the stock market doesn't give that impression, but the support there is quite narrowly focused on tech companies that are actually benefitting from the current situation. Also, the Fed is handing out massive amounts of cash to banks and financial institutions, and that money that has to go somewhere. Stocks may potentially have short-term issues, but what else are you going to buy in a world where the 10-Year yield is just over 0.5%?

Natural gas and other commodities with real-life, practical uses, however, don't benefit from that. They are not long-term investments that offer yield or the prospect of a yield. If, as looks likely, the "recovery" from the shutdown is at best delayed if not completely reversed, natty will reflect that over the next few days, maybe even week or two and a drop back, maybe even to challenge the lows of a couple of weeks ago at around $1.60, looks likely.