Summary

The lowest level since 2016 in August.

The rally came too early.

Inventories rise above the 2018 pre-withdrawal season peak.

Buying on a scale-down basis for the winter months – a bullish reversal on Oct. 3.

UGAZ for short-term trades on the long side of the natural gas market when the market turns.

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Natural gas is one of the most volatile commodities that trade on the futures exchange. The range since 1990, when the energy commodity began trading on the NYMEX division of the CME, has been from a low at $1.02 to a high at $15.65 per MMBtu.

The market has matured dramatically over the past three decades. Massive discoveries of natural gas reserves in the Marcellus and Utica shale regions of the US and technological advances in extracting the gas from the crust of the earth have increased the supply side of the fundamental equation. Since necessity is the mother of invention, natural gas demand has moved significantly higher at the same time. Gas has replaced coal when it comes to generating electricity in the US. At the same time, natural gas in liquid form now travels by ocean vessel around the globe, whereas it was confined to travel by pipeline in past years. The demand side of the equation has grown alongside the supply side.

Increased liquidity in the natural gas market has compressed the price range. However, the price traded in a range from a high at $4.929 to a low at $2.029 per MMBtu between November 2018 and August 2019. As we move closer to the peak season for demand each day, the price was below the $2.30 per MMBtu level at the end of last week. Natural gas is back in the buy zone as the injection season will end in mid-November, and inventories will begin to decline.

The Velocity Shares 3X Long Natural Gas ETN product (UGAZ) and its bearish counterpart (DGAZ) are short-term tools that make it possible for market participants to position in the volatile market without entering the future arena.

The lowest level since 2016 in August

In early August, the price of nearby natural gas futures on the NYMEX division of the CME dropped to a low at $2.029 per MMBtu. During the injection season, when inventories were climbing, many market participants believed that the price would fall below the $2 level for the first time since 2016 and challenge the March 2016 low at $1.611 per MMBtu. However, the price never probed below the psychological level, and it took off on the upside. By mid-September, the price of the energy commodity recovered to a high at $2.71, a move of over 33.5% in six weeks. Natural gas is combustible in its physical form, and the price action reflected the characteristics of the energy commodity.

The rally came too early

I had done some light buying of call options for expiration in the winter peak-season months during the summer when natural gas was down below the $2.30 level. However, those who follow my weekly musings on the natural gas market know that I believed the rally that took the price over 30% higher came too soon. After reaching the high during the week of September 16, the price ran out of steam on the upside.

Source: CQG

The weekly chart highlights that the price fell as fast as it climbed, reaching a low at $2.207 per MMBtu last week. The move to the downside caused the price momentum and relative strength indicators to trend lower, but they remain on either side of neutral territory on the weekly chart as of Friday, October 4. The total number of open long and short positions in the natural gas futures market at 1.215 million contracts is has moved lower over the past weeks.

Moreover, last year, during the same week, the open interest metric stood at 1.684 million contracts, around 469,000 contracts or over 38.6% higher than the current level. In October 2018, a short natural gas versus long crude oil spread blew up in the face of speculators in the energy patch. The positions contributed to the move to almost $5 in the natural gas futures market and a plunge from $76.90 to $42.36 in the NYMEX oil futures market. Similar moves do not appear to be in the cards for either market over the coming weeks. One of the reasons why natural gas took off to the upside during the fourth quarter of 2018 was that stockpiles fell to the lowest level in years.

Inventories rise above the 2018 pre-withdrawal season peak

On Thursday, October 3, the Energy Information Administration told the natural gas market that stocks rose more than the market had expected. The consensus was for a 100 billion cubic feet increase in the amount of the energy commodity in storage. The EIA reported that they rose by 112 bcf for the week ending on September 27.

Source: EIA

As the chart shows, inventories stood at 3.317 trillion cubic feet as of the end of September, which was 16.3% above last year’s level, but still 0.5% below the five-year average for this time of the year.

Moreover, natural gas stocks rose above the peak from last year with the latest EIA report. In 2018, pre-peak season stocks rose to just 3.247 tcf before the start of the withdrawal season. This year, stocks eclipsed last year’s high with around six weeks to go in the injection season.

The knee-jerk reaction in the natural gas market was selling.

Source: CQG

The ten-minute chart shows that the initial response to the latest EIA inventory data took the price to the low of the week at $2.207 per MMBtu, where buying suddenly emerged.

Buying on a scale-down basis for the winter months – a bullish reversal on Oct. 3

In last week’s natural gas piece on Seeking Alpha, I wrote, “With the peak season for demand less than two months away, the current price weakness could be another opportunity for long positions. Seasonality could limit downside risk over the coming weeks.” It turned out that buying on a scale-down basis over the past week turned out to be the optimal strategy in the natural gas futures market and related products.

Source: CQG

The daily chart shows that natural gas futures put in a bullish reversal on the daily chart on Thursday, October 3. Market participants ignored the higher than expected injection into storage and the rise above last year’s high in pre-withdrawal season inventories. The uncertainty surrounding the weather conditions this winter made market participants think twice about pushing the price of the energy commodity lower in the aftermath of the EIA data release. Price momentum and relative strength metrics both turned higher in oversold territory. On Friday, October 4, the price was above the $2.35 per MMBtu level on the active month November NYMEX futures contract after reaching a high at $2.398.

UGAZ for short-term trades on the long side of the natural gas market when the market turns

We should expect lots of price action in the natural gas futures market over the coming weeks as the injection season winds down. Wide price ranges are a paradise for traders with their fingers on the pulse of markets. Natural gas attracts lots of speculative interest when the price of the energy commodity is moving.

The most direct route for risk positions in the natural gas market is via the futures and futures options on the NYMEX. For those who do not have access to the futures arena, the Velocity Shares 3X Long Natural Gas ETN product and its bearish counterpart DGAZ provide the opportunity to trade natural gas in ordinary equity accounts. The fund summary for UGAZ states:

The investment seeks to replicate, net of expenses, three times the performance of the S&P GSCI Natural Gas Index ER. The index comprises futures contracts on a single commodity and is calculated according to the methodology of the S&P GSCI Index.

Source: Yahoo Finance

UGAZ has net assets of $540.28 million. The highly liquid product trades an average of over 13.7 million shares each day and charges an expense ratio of 1.65%. The price of natural gas moved from a low at $2.207 to a high at $2.398 on from October 3-4, a move of 8.65%.

Source: Barchart

Over the same period, UGAZ rallied from a low at $12.56 to a high at $15.84 per share or 26.1%, triple the percentage move in the natural gas futures market.

DGAZ operates inversely to UGAZ. The bearish product has net assets of $231.6 million, trades an average of over 912,000 shares each day, and charges the same 1.65% expense ratio. The price of December natural gas futures fell from $2.745 on September 17 to the low at $2.207 on October 3, or 19.6%.

Source: Barchart

Over the same period, DGAZ rose from $85.41 to $157.00 per share or 83.8%. DGAZ’s price reflected a return more than triple the percentage move in the natural gas market on the downside.

Natural gas fell back into the buy zone over the past two weeks. The winter season is now a little over one month away. I continue to expect a rally that will take to the price of the energy commodity towards $3 on the January futures contract at some point. January futures fell to a low at $2.533 last week and were at around $2.66 per MMBtu last Friday.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.