When you're trading in an asset that has seen prices range from $150 to $33 per barrel since 2008, timing is everything. That move in crude represents $117,000 per futures contract, thus proving this market to be one of the most lucrative among commodities, but also among the most treacherous. As tempting as it might be to chase prices higher into a rally, it can often be a painful lesson in market timing.
If we take a quick look at the fundamentals, we'll see enough reason to justify why crude bulls on the sidelines should wait for a respectable pullback before they buy. Seasonal tendencies offer convincing support of this theory, as well. Crude-oil prices have benefited from higher equity prices, commodity traders take as a sign that the economy is growing -- and, therefore, that energy demand will rise. However, domestic inventory has been on the rise. U.S. wares are currently believed to total about 360,000, well above the five-year average. Yet, crude prices continue to float higher on the possibility of future demand, rather than moving on existing market fundamentals.
From a seasonal standpoint, January tends to be a generally weak month for crude-oil prices, but it often provides bulls with what eventually become attractive buying opportunities. Crude prices have a tendency to find a bottom in early February, and then to rally through mid-May as refiners build inventories in order to begin preparing for the summer driving season. According to the Commodity Trader's Almanac, buying on the February dip has worked in 24 of the previous 29 years, for a win ratio of about 82.8%.
Traders might want to look to the chart for help as they prepare to get bullish into what we believe will be a January dip. Technical analysis suggests the current rally is running out of steam, and that it should be contained by resistance near $95. If so, a minimal pullback should hit the $90 level, though we believe odds are in favor of the mid-$80s. If the price reaches that zone, it could turn out to be a great opportunity to "get long" with options or futures ahead of a possible seasonal rally. In the short term, aggressive traders might consider nibbling on hedged bearish trades. (We are currently short strangles in this market.)
Natural Gas Is Cheap, but It Could Get Cheaper
Natural gas appears to be one of the cheapest commodities on the board, and it is! But that doesn't mean it can't get even cheaper before it makes a meaningful recovery. The supply glut for this commodity has become so overwhelming that many oil-and-gas plants are simply burning off part of their inventory; apparently it cheaper to dispose of it than to try transporting and selling it.
The supply surge is largely due to the growing popularity of "fracking," a high-tech extraction method developed in the recent decade to pull otherwise untouchable natural gas from cracks in rock layers. However, free markets eventually adjust to pricing, and natural gas is certainly a cheaper source of energy than is crude oil or its refined versions. At some point we should see sharp increases in demand as consumers seek lower-cost alternatives. Accordingly, in our view, we should be prepared to approach the market with a bullish tilt as we head in to February, which normally favors a seasonal buy.
For natural gas, the Commodity Trader's Almanac suggests that going long from late February to late April boasts a 72.7% success rate, given gains in 16 of the previous 22 years.
Look for the January dip to run well into the area of $2 per MMBtu. We see support near $2.60, but there appears to be substantial potential for the selling to reach the $2.10s.