Thursday, February 3, 2011

Why Natural Gas Is A Short

Update (Feb 9)

The natgas short couldn't have played out any better. UNG gapped lower on Monday and continues to bleed as of mid-day today. (See initial Feb 3 report below)

I took profits on my HND.TO position earlier this week @ 9.12 (+1.34) and 9.33 (+1.34). After UNG hit a low of 5.43 and bounced I took profit on the balance of my HND.TO @ 9.38 (+1.39). The trade averaged gains of almost 20% in less than one week.

With the extreme cold much of the Northeast is getting right now, plus another EIA report to be released tomorrow morning, we could definitely see natural gas prices bounce from here on short covering. But I am not convinced we have seen the lows yet.

Risk/reward does not warrant initiating new swing trades here. I went long a few UNG this morning @ 5.49 looking for a bounce, but will be out of that trade win or lose by tomorrow morning at the latest.


Short-Term UNG Target: 5.35-5.50 (Feb 3)

Natural gas had been looking pretty strong since breaking out of a downward channel in November. However, in late January the US Natural Gas ETF (UNG) staged a failed breakout above 6.40. And ever since it has been on the defensive.

This morning it had bounced and was testing its 20 day moving average before the release of the EIA's weekly storage data at 10:30am. I used this level as an opportunity to short natural gas by going long HND.TO @ 7.78, and tweeted the trade at the time.

The rationale?
  1. The chart was already looking weak. I had been watching natural gas and waiting for a bounce to sell into. The 20 day moving average was a natural resistance level.
  2. Weather has been cold. That's bullish, right? Yes, but the problem is that EVERYONE already knew that it was cold. Therefore, in my view, there were likely a lot of weak longs still hanging on. And weak longs always make for a vulnerable stock (or commodity). Selling natgas once the cold hits is analogous to "selling the news".
  3. The market was looking for a steep storage draw at 10:30am. Reuters was calling for 190 and some forecasters were looking for as much as 217. My analysis said that while it was cold, it was unlikely to result in a draw near 200. A weaker than expected draw should see a bearish reaction.
  4. No matter what the draw, there is still an awful lot of gas in storage against virtually any metric.
So far, so good. The actual # was 189. A large draw, but not nearly enough to bring new buyers into the market. As a result the market sold off for most of the day post-EIA #. As I write this UNG is trading @ 5.90.

Technically, UNG put in a bearish reversal candle today, and looks set to close beneath its 20, 50, 100 and 200 day moving averages. To me this points to a technical target of 5.35-5.50 over the next several days. Only a move back above 6.10 would reverse this bearish view in my opinion.

Longer term I like natural gas, but it's not time to go long yet...


  1. Nice job, loved it until the last line...

  2. I don't like to look at UNG as an indicator for NG_F spot prices given the make up of the UNG ETF fund (have you ever dug into the balancing?). Mid term you have seasonality on your side for a short going into the summer (end of apr into may/june) (if not a flat line here). The chances of seeing a $3 handle is greater, but at the same time your analysis is looking at the technicals of the UNG and not spot, whereas spot is more driven by EIA data. Also, there was an early morning attack today to get NG_F under $4, about 600 cars just after 5am before anyone was awake).

    You also don't factor in weather enough, or longer term political drive to increase demand use of NG over CL as an alternative energy stock.

    Also look at the options chain... not to mention the roll over from Mar contract to April.

    Simply put, the smart money has already made money in the short... Next move, in my opinion, is a bounce to about $4.20 on the front month spot that will open up a new window to short.

    Might be better to go long UNG, and look to put options for short term hedging.

  3. @Anonymous I am intimately familiar with how UNG is constructed. I would never look at a long-term UNG chart (i.e., > 1-year) to come up with natgas trade ideas. But for a 1-week trade based on a 3-4 chart it is more than sufficient, and in fact superior to a continuation NGc1 chart since the NGc1 chart doesn't account for seasonal spreads between months. Also there is a lot of investment funds playing UNG, so it is important to be aware of key technical levels in it.

    Also, looking at NG as an alternative fuel is useless when looking for a 10% move in 1-week. Besides, look at stocks like WPRT and CLNE if you want to see how much the market is valuing the probability of natgas as an alternative fuel right now. I shorted WPRT last week @ 15.73. It was down 8% today.

    If you want to look at longer-term trends or risks, look into how the city of Buffalo just passed regulations banning hydraulic fracking. If the environmentalists gain traction in banning hydraulic fracking in other areas in the US then you can kiss all that cheap shale gas goodbye. Then you will truly see natgas prices spike higher. But again, this is outside the realm of a 1-week trade.

    I shorted HND.TO last week when natgas was 4.47 and covered last piece today at 4.04/4.05. Picked up a few more cents afterward on a daytrade long in UNG (all tweeted). I am on the sidelines now until risk/reward improves.

  4. Here's a link on the Buffalo fracking ban if anyone is interested.