Natural Gas Bulls Should Be Patient

While scouring the latest market sentiment polls and the trusty COT (Commitments of Traders) report, it is clear to us that most speculators are bearish in natural gas. This should come as no surprise. In the U.S. there is a long-standing supply glut and domestic producers have not ironed out the kinks when it comes to liquifying and exporting the energy. Further, the state of California is proposing policies that will phase out the consumption of natural gas (which is odd because it is a relatively clean fuel source). However, in the long run (years not weeks) the fundamentals are quite impressive. U.S. politicians seem eager to ban fracking and the practice of exporting our energy resources in this area is bound to improve. Accordingly, we tend to favor a strategy of getting bullish on large dips, but not getting greedy on the rips. Natural gas is a trader's market, not a long-term investor's market. Those who forget that will pay a hefty tuition to the market for the lesson. Seasonal Chart According to seasonal stats put forth by our friends at MRCI (Moore Research Center Inc.), natural gas futures tend to bottom in late October or early November. Obviously, this leaves us with a two to a three-week gap of potential weakness before seasonal support comes in. That said, seasonal tendencies are a guide but not a fail-safe method of predicting prices. Even seasonal patterns that materialize can be early or late. Nevertheless, it is a compelling argument for traders to be prepared to establish bullish trades near the turn of the month depending on where prices lie. Source: MRCI COT Report The COT Report issued by the CFTC (Commodity Futures Trading Commission) is our go-to source of market composition information. This report depicts how the various types of traders are positioned in the market. This differs from a sentiment index in that it tells us where traders have put their money, not just their mouths. Speculators are still holding relatively decent net short positions, but we are no longer at the extreme levels we were a few months ago. In other words, many of the shorts have covered but now could be willing to put those shorts back on given weak price action. In our view, the current market make-up suggested prices will continue to soften in the short run as the bears put short positions back on. This premise is corroborated by the Consensus Bullish Index service, which suggests that only 31% of industry insiders polled were bullish in natural gas futures. Source: Barchart The Natural Gas Futures Chart Some argue natural gas is currently cheap, but I argue otherwise. Not being expensive does not translate into cheap. Nevertheless, natural gas futures haven't spent much time below $2.00 per MMBtu -- this gives the bulls a floor to work upon. Of course, prices can slide beneath $2.00 at any time as we have seen on occasion in the past. Nevertheless, that is what hedges are for. A retest of recent lows would put the December natural gas futures near $2.33, but in our experience, the energy markets tend to run sell stops. Thus, $2.25ish would be likely seen on a flush lower. Yet, if seen such a price is seen, it will probably be an opportunity for the bulls. This is because not only would it have washed out the weak bulls, which is a common occurrence before a trend change, but it would leave the market with extreme oversold readings in oscillators such the RSI (Relative Strength Index). Source: QST While bullish plays from the $2.25ish area appear to be attractive, traders must acknowledge the possibility of a temporary plunge to $2.00. Thus, it is important to either hedge the trade with long puts (preferably cheap) or keep position sizing appropriate for the potential risk.

Natural Gas Bulls Should Be Patient

We tend to favor a strategy of getting bullish on large dips, but not getting greedy on the rips.

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