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Natural Gas: Fading the Weather

Nat Gas

Traders have a tendency to become obsessed with news and data. When you sit in a room all day trying to predict the next movement in something that is inherently unpredictable it is only natural to look for solid things that could give you clues. Thus, for stock traders, any economic data, no matter how obscure, is pored over and analyzed. Currency traders do the same with anything said by central bankers. For oil traders it is the historically unreliable weekly inventory figures or, even more bizarrely, an estimate of oil stocks from the API that often bears little resemblance to the official numbers. Natural gas traders, like the natives of my home country England, are obsessed with the weather.

More accurately, I suppose, they are obsessed with weather forecasts, and that creates an opportunity for traders. There are sound reasons why those forecasts affect natural gas prices as much as they do, but the very nature of them makes fading the moves that they cause a trade that wins more than it loses.

(Click to enlarge)

Natural gas is rapidly moving to a dominant position in electricity generation in America and has a healthy toehold as another power source in U.S. homes, and clearly the weather has a direct effect on domestic power consumption. We obviously use more power to heat and cool buildings when the weather is extreme, but energy usage can also be affected by weather that is simply a little unseasonal. As I write this I am in New England, looking out at a day where temperatures are forecast to get close to 80 degrees Fahrenheit. Heating my home, which would be normal practice at this time of year, is the furthest thing from my mind right now.

That forecast for today, like most short-term weather forecasts, looks like being pretty accurate, but long-term forecasts are what move natural gas and that makes little sense on two levels. Firstly, meteorology has made enormous strides over the years and these forecasts are founded on good science, but are still often wrong. Secondly, even when they are right, we all know from our own experience that weather changes, so their influence is inherently short-term.

That is why, when I hear that natural gas futures have fallen or risen on expectations for warmer or cooler weather my first instinct is to fade that move. It is not something that can always makes sense immediately, but when gas has been bouncing around in a range as it has recently it can be a prompt to buy anywhere near the bottom and sell anywhere near the top.

At the moment, I particularly like to buy on forecasts for milder weather that drive prices down. The usual short-term nature of the moves caused by them still apply, but with the added bonus that, according to my fundamental view, there is the potential for long-term bullish influences for natural gas from exports and demand increases which limits how low we go. It is that shifting focus between short and long term influences that has caused the kind of range trading that we have been seeing in natural gas that has resulted in a number of opportunities in both directions.

As we head towards the top of that range there will undoubtedly be others. If a forecast comes for a cold snap that pushes us the rest of the way to the top of the range then selling into that move just below the top would work. Alternatively, if a return to expectations for a mild winter forces us back towards the bottom of the range, NG would be a buy. Note that this only applies as long as all else remains roughly equal. A breakout will come at some point, and If the fundamental supply/demand balance shifts in a more long-lasting way, that, not weather forecasts, should be your focus. For now though, if weather forecasts push natural gas in one direction, trade in the other.

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