February Natural Gas
The big story the past week was the nearly 25 percent surge in February Natural Gas futures prices. The move was driven by the change from extremely warm temperatures in key demand areas in December to forecasts of below normal temperatures for early January.
After settling at its lowest level in 16-years on December 17, natural gas went on a tremendous run which took prices to their highest level since November 19. The move took many traders by surprise, causing a short-squeeze in the January futures contract, which expired on December 29.
The price action on December 30 suggests the market may have posted a short-term top. If this proves to be true then we could be setting up for the all-important correction next week.
Following a prolonged move down in terms of price and time, the first rally from an extreme low is mostly short-covering. Once the market stops going down or unexpected news hits the market, short-sellers will pay anything to protect their profits. This creates a buying frenzy as sellers continue to raise offers and buyers continue to chase the market higher. This is what we may have seen the past two weeks.
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Technically, the main trend is down according to the weekly swing chart. The main range is $3.097 to $1.802. Its 50% level at $2.450 is the primary upside target along with a downtrending angle at $2.497. Most initial rallies from important bottoms end on a test of a key retracement zone. This week, the rally seems to have stalled at $2.386, or slightly below the first objective.
There is still the possibility the market will complete the move, but if it doesn’t then traders should prepare for a retracement of the first rally from $1.802 to $2.386.
If a sell-off begins then the first objective will be the steep uptrending angle at $2.282. If buyers come in to support the market on a test of this angle then the market will appear to be more bullish than previously thought.
If the angle at $2.282 fails to hold then look for natural gas to complete a full retracement into $2.094 to $2.205. Trader reaction to a test of this area will set the near-term direction. Aggressive counter-trend buyers may step in to stop the price slide in an effort to form a potentially bullish secondary higher bottom. Trend traders are going to try to drive the market through this zone in an effort to go after the main bottom at $1.802.
There should be a lot of price action and order flow on a test of $2.094 to $2.025 as buyers and sellers battle it out for short-term superiority. Buyers will be driven by the weather forecasts so any rallies are likely to be fast and violent. They are fighting the clock because cold temperatures are expected to come and go quickly during this year’s El Nino winter season. Sellers, on the other hand, will take their time driving the market lower once they regain control. They know that time is on their side because of the bearish supply fundamentals.
In summary, stripping out the weather concerns, the best shorting opportunity will come on a test of $2.450 to $2.602. The best counter-trend buying opportunity will come in on a test of $2.094 to $2.025, but in order to lead to a rally, buyers are going to need help from the weather, namely a forecast of below normal temperatures. Unless a lingering cold front appears, most of the rallies will be short-lived so if playing the long-side, look for quick exits.
XLE – Energy Select Sector SPDR Fund
Going into the start of the new year, I believe the equity market to watch will be the XLE, or Energy Select Sector SPDR Fund.
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At the end of 2015, the XLE is trying to form a potentially bullish double-bottom. This may be end-of-the-year position-squaring, but nonetheless, this market should be watched carefully. Setting aside the bearish crude oil fundamentals, aggressive portfolio managers may decide to take some of their cash out of equity markets that have outperformed and redeploy the profits into equities that have underperformed. This action could trigger an early surge in the XLE.
The key level to watch early in the year is $62.29. This price may be the trigger point for an acceleration to the upside. The initial move is likely to be a combination of aggressive counter-trend buying and short-covering. The actual change in trend to up will take place on a breakout over $71.93. However, the formation of a support base between $60.00 and $58.00 will suggest that buyers are coming in to support the market.
In summary, if you’re an equity trader looking for a bargain in 2016 then, in my opinion, the XLE is the exchange traded fund to keep your eye on. We’ll be watching this market on a weekly basis during 2016, but if you want to get a quick jump on what can potentially be a solid trade in 2016, start watching the price action in the XLE early in the year.