There are two deeply conflicting sides of the natural gas trade heading into late summer. On one hand, we’re coming off a record setting El Nino that is translating into a La Nina late summer/fall weather pattern. The post El Nino, La Nina weather pattern is already bringing the expected heat that comes with it but speculators want more. They want more heat and they want the hurricane season to be an active one. These are the two bullish components of a fundamentally weak natural gas market. Natural gas producers are selling forward production at their fastest rate since the fall of 2013. The question here becomes a bit more ambiguous as producer selling can have as much to do with selling forward supplies to raise cash as it can the their expectation of current market prices versus forward prices. We’ll look at weather patterns, seasonality and the commercial trader vs speculator balance in the market to determine a proper course of action heading into this market’s critical seasonal period.
Let’s begin with the natural gas market’s typical seasonality. First, understand that commodity futures are priced as forward contracts. Therefore, we expect commercial trader action to take place prior to the seasonal moves as the commercial traders determine what they have to deliver or, what they want to take delivery of at the contract’s expiration. Commercial traders anticipate their customers’ needs and regulate their supply, accordingly. There are two primary periods of seasonality in the natural gas futures. The hot summer months when natural gas is used to generate electricity to cool the country and, conversely, the chilliest of winter months as the country needs warmed. This shows up as commercial buying during the seasonally weak period of January through March and producer selling at the peaks of seasonal strength of June and again in October. This is the collective anticipatory behavior of the commercial traders.
Next, we’ll take a look at the weekly natural gas futures chart with our Commitments of Traders overlay. We’ve highlighted some major points, including the three previous years’ windows of seasonal opportunity. Note also, the major trend line falling from early 2014. We view the recent commercial selling pressure as the fundamental reinforcement of technical and seasonal resistance.
The issue of fundamental weakness in the natural gas market is currently being debated as some analysts expect the summers’ predicted high temperatures along with increasing natural gas exports to limit domestic supply thus, causing prices to rise. The Energy Information Agency (EIA) disagreed with this assessment in their July 12th report. While they acknowledge the impact of rising electricity usage due to higher temperatures, noting that power-sector gas demand is expected to rise 4.9% in 2016. And they note our growing stature in the global natural gas market, “For the first time since 1957, the United States is on track to export more natural gas than it imports; this will occur during the second half of next year as more liquefied natural gas export capacity comes online,” said EIA Administrator Adam Sieminski. The report disagrees with the notion that supplies will be hampered, “there are still abundant supplies to meet domestic demand as natural gas inventories are expected to be at a record high for the start of the upcoming winter heating season.” In summary, the EIA sees current supplies as substantial while suggesting a late fall bump in prices of 2.5%, in line with currently above average seasonal temperatures. This is far less than the 20%+ this market has rallied since June 1st.
Moving to the daily chart we’ll examine our standard Commitments of Traders swing trading approach. Our approach begins with finding large imbalances between the commercial and speculator trading groups. This is where the difference between speculators’ anticipation of a massive hurricane season contrasts with natural gas drillers’ expectations of forward prices. The speculators here aren’t just whistling Dixie. There is sound evidence to support their dismal weather forecast as many of the worst hurricanes and hurricane seasons have come during La Nina years, including 5 of the last 7 Billion Dollar weather events. The imbalance that’s within the natural gas futures market between the commercial drillers and the speculators is very similar to a craps table layout with the speculators playing every bet on the, “Pass” and “Come” lines while the commercial traders sit back on the “Don’t” line, waiting for the most likely roll of the dice and a “Seven out. Pay the, ‘Dont’s.'” The longer this roll goes on, the wider the disparity becomes in the wagers the two groups are placing as shown in the bottom pane’s, net positions.
The rules of this method are pretty straightforward and put us inline to go short the natural gas futures at a seasonally weak point in time. First, we only trade with commercial momentum, which is plotted in the third pane. We look for buying opportunities when commercial momentum is positive and we look for short-selling opportunities when their momentum is negative, like now. Second, we wait for the market’s action to place it at odds with the commercial traders’ collective outlook. In other words, we’re looking for oversold markets to buy when commercial trader momentum is bullish and we’re looking for overbought markets to sell when commercial trader momentum is bearish. We track this using our proprietary, “Market Momentum Trigger.” This situation last presented itself when we sent out a COT Sell signal on July 5th.
We feel that, barring an extraordinary hurricane season; the broader dynamics of this market could force it lower for the next several weeks. Furthermore, the technical trading pattern lends itself to selling a breach of the support at $2.65. If the market falls through, it would confirm a swing high and allow us to place a protective buy stop at the overhead resistance of $3. The first support for this trade could be as low as $2.20 as this is would be the first touch of the trend line coming up from the March lows. Beyond that, the psychological support at $2 is still the key to preventing further price erosion.
For more information on how we use the weekly Commitments of Traders report to generate actionable discretionary and mechanical daily trading signals, please visit CotSignals.com.
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