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Martin Tillier

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An Overlooked Opportunity In Natural Gas

About a month ago, I wrote that while natural gas was bouncing after a big drop at that time, shorting when that retracement showed signs of ending was the trade to take. If you followed that advice, you probably wouldn’t have hit the high of that bounce above $3.70 but would quite likely have sold somewhere around $3.40-$3.50, once the reverse was confirmed. By now you would either have banked a nice profit or be sitting pretty. That analysis was based on a reading of a long-term chart however, and the same chart now says that it is time to take the opposite tack and buy.

(Click to enlarge)

The reason is the most basic one of all when it comes to chart analysis, a clearly defined support level. As you can see, since coming off the low of $1.611 achieved early in 2016, the NG futures contract has bounced off the $2.50 level, marked by the blue line on the chart above, a total of six times. We are now close to that level again.

Now, anyone who has ever traded knows that that doesn’t guarantee that we will move higher from here. The chart also shows, by virtue of that 2016 move, that prices can go a lot lower than $2.50, so that is always a possibility. What it does though is increase the likelihood that we move up from here, and there are other, fundamental things that support that contention.

Probably the biggest fundamental factor that has pushed natural gas lower is oversupply. The shale boom in the U.S. has led to more natural gas being recovered in general, but the biggest recent impact has been from the fact that much of that gas, which didn’t find its way to market until recently, now does.

Oil output from the Permian basin has expanded rapidly in the last year or so, and according to the EIA is expected to continue to grow. Until recently, much of the natural gas that has been recovered in those operations has been burned at the site, but that is beginning to change. Pipelines are being built to carry the gas from the Permian, and that supply increase has affected pricing everywhere.

That increase has been foreseeable for some time though, and probably wouldn’t have had as big an impact, were it not for demand factors. The massive spike in gas futures at the end of last year was caused by the expectation of extreme cold, but now that the polar vortex has come and gone, we are moving into the spring season with mild temperatures forecast. Given natural gas’s dominant position as a fuel for electricity generation, the prospect of neither heaters nor air conditioners running in the U.S. naturally makes for a pessimistic demand forecast.

The thing is though, at these levels, all of that is pretty much priced in, and there is a chance of a significant move up based on market positioning. Weather forecasts have been known to change and while pipeline projects still have a friendly Federal environment, the Democratic victories in last year’s elections make local and state opposition much more likely. With the amount of selling that has driven us to this point, even a slight change to the weather, a small delay in a pipeline project, or some other unforeseen bullish influence could result in a quick short squeeze that would exaggerate any move up.

The biggest factor though is basic supply and demand theory. At these lower prices, recovering, liquefying and transporting gas becomes a much less attractive proposition, regardless of access to infrastructure.

All of the above is, of course, speculation, but that is what trading commodity futures is about. What traders try to do though is assess which is the most likely direction of the next move at any given time, and right now, back up seems to be the path of least resistance. Even so, the extreme volatility in natural gas futures makes it essential that any position is protected by a stop loss, and in that regard too, current pricing is a plus. The proximity to the $2.50 level allows for a stop just below that, say somewhere in the $2.45-$2.47 range, that would make for a relatively cheap cut should the level break.

Because of that volatility and the recent lack of logic in the market, I would keep all positions in natural gas small right now. If a move back up does develop, you can always add to the position. With that proviso, and with suitable stop loss orders though, the case for buying NG on such an obvious, significant support is strong.

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