Why The Natural Gas Rally Isn’t Over Yet

Crude oil took a backseat to the natural gas market this week with prices soaring 7.52% since last week's close and 16.35% since the close on May 27. Thursday's close in the July Natural Gas futures market was $2.593, its highest close since the week-ending January 8.

The main trend is up according to the weekly swing chart. The strong close has put the market in a position to take out the high for the year at $2.635. This is followed closely by another top at $2.684. The rally could expand greatly above this level with the next top coming in at $2.961.

The main range is the $3.227 top from the week-ending May 22, 2015 to the $1.939 bottom from the week-ending March 11, 2016. Its retracement zone at $2.583 to $2.735 is currently being tested. A long-term downtrending angle passes through this zone this week at $2.667, making it a valid upside target also.

Trader reaction to this retracement zone is likely to determine the strength and direction of the market over the near-term. Short-sellers see value so they are likely to initiate new position. Speculators are buying and they don't care too much about value. They are more interested in maintaining the current upside momentum.

(Click to enlarge)

Based on the close on June 9, the direction of the market on Friday and next week is likely to be determined by trader reaction to the main 50% level at $2.583.

A sustained move over $2.583 will indicate the presence of buyers. This could lead to a test of the main top at $2.635, the downtrending angle at $2.667 or another main top at $2.684. The latter is the trigger point for a rally into the main Fibonacci level at $2.735.

The Fibonacci level at $2.735 is most important to the structure of the market since it is the trigger point for a strong acceleration to the upside. Taking out this level with conviction could create enough upside momentum to challenge the long-term downtrending angle at $2.947 and the main top from $2.961 from the week-ending September 18, 2015.

The primary catalyst behind the rally is a swatch of above-normal temperatures stretching from the Southwest to the Midwest over the next two weeks. This is leading to a huge surge in demand across a wide area.

On Thursday, however, the market was hit with another piece of bullish news. According to the U.S. Energy Department, natural gas stockpiles rose 65 billion cubic feet in the week-ended June 3, falling well short of the 79 million cubic foot increased predicted by industry analysts.

For natural gas bullish traders, it was a version of a perfect storm with production falling at a faster pace than expected, at a time when demand is rising.

(Click to enlarge)

Since we are primarily in a weather market with supplies still hefty and about 32.1% above average for this time of year and with nearly three trillion cubic feet of gas in U.S. storage, we feel obligated to talk about the downside risks we see on the chart.

We said earlier that the direction of the market on June 9 and next week is likely to be determined by trader reaction to the key 50% level at $2.583.

A sustained move under $2.583 will indicate the presence of sellers. They may be speculative profit-takers or fresh short-sellers. If they do come in with big volume then expect a minimum correction into a pair of short-term uptrending angles at $2.499 and $2.400.

The move will expand to the downside under $2.400 with the best targets at $2.219 and $2.160.

Essentially, any bearish news is going to drive the market back into its two-month trading range. Typically, it will sell-off 50% of its last rally from $2.0800.

There are a lot of numbers to look at so we'll just say that you just watch the price action and order flow at $2.583 all week. This price will control the direction of the market. A sustained move over it will give natural gas an upside bias. A sustained move under it, a downside bias.

If the rally continues to gain traction then the second key level to watch will be $2.735. This level may act as resistance on the first test, but it is also the trigger point for a huge acceleration to the upside.

Fundamentally, we have numerous factors supporting the market at this time, but a change in the weather will have the most immediate influence on the price action. These factors include lower production, the switching of power plants from coal to gas-fired generation and burgeoning exports.

Combine these factors with intense heat and the rally will be sustained. Take away lower production and gains will be limited. The return of normal temperatures, however, will likely trigger a break.