Wednesday, September 2, 2009

Reader Question: Natural Gas

A reader wanted to know my "technical take" on natural gas, and I would be happy to share what I have on the subject.

First a bit of house keeping. My price chart for natural gas is constructed utilizing the daily cash data. The closing prices are slightly different from the continuous futures data that I have on TradeStation. This does not materially affect our analysis especially if we are looking for changes in the secular trend.

Let's start by looking at a monthly chart of natural gas. See figure 1. This is not pretty. The close below three pivot low points is a pattern that I have identified that is consistently bearish across multiple markets and time frames (weekly and monthly price charts). On a monthly chart of natural gas, a monthly close below 3 pivot low points has never occurred before. August, 2009 resulted in a close below three pivot low points and a close below support levels as noted by the red trend line. The break down also occurred on a wide range price bar, which I would generally consider pretty conclusive. The most recent prior pivot point low is at $3.25, and with price currently at $2.37, I would consider that breakdown pretty significant.

Figure 1. Natural Gas/ monthly

Of note, the all time lows occurred around $1.50 for natural gas.

All this analysis is bearish, and natural gas is currently in "no man's land" - neither near support or resistance. I would not be a buyer of natural gas until there is a monthly close above the $3.25 level; what was support is now resistance. On the other hand, a spike down towards $1.50 (support) would be a place to get in on the panic lows.

So that is the technical situation. But a reasonable question to ask is and one that I ask frequently of many assets: is natural gas poised to undergo a secular trend change? See figure 2, a monthly chart of natural gas. The indicators in the figure attempt to identify the technical conditions that might lead to secular trend changes.

Figure 2. Natural Gas/ monthly

The "next big thing" indicator is in panel 2. This is not in a position where we would expect a secular trend change. The indicator in panel 3 looks for statistically significant consolidations in prices; generally this contraction in volatility may lead to a breakout and a trend change, but prices are not consolidating. They are trending lower. The indicator in panel 4 is newly developed over the past 6 months, and it is based upon Larry Williams' "Pro Go" indicator. The idea behind the indicator is to identify those times when retail traders are dominating the market action. With the indicator nearing extremes, the retail trader has ridden natural gas lower for the better part of the last year. It is in these kind of extremes that the "smart money" or strong hands take shares off the weak hands. In the final analysis, I don't believe natural gas is poised to undergo a secular trend change.

The most compelling evidence that I can find that natural gas has been oversold to a very extreme degree can be seen in figure 3, which is a monthly chart of natural gas. The indicator in the lower panel measures the ratio of the price of a West Texas crude oil to the price of natural gas. Crude oil is trading at 25 times the price of natural gas. In the past, when this ratio was greater than 11, natural gas exploded higher for at least one month; these times are noted by the maroon vertical bars. Of note, the most significant failure in this relationship came at the most recent market top for natural gas in July, 2008. In addition, the ratio of crude oil to natural gas has been above 11 for over 6 months, and still there is no bounce. I guess what "everyone" knows really isn't worth knowing.

Figure 3. Natural Gas/monthly

In the final analysis, I don't believe natural gas is poised to undergo a secular trend change. Furthermore, price is in "no man's land" - it is neither near support or resistance. Lastly, with the ratio of the price of crude oil to the price of natural gas so extreme, I cannot rule out at least a short term "pop". However, this relationship has failed miserably over the past 12 months.


ZachA said...

What about hedging a long position in natural gas with a short oil position? The thought being, the high relative price can be adjusted if oil falls more than natural gas.

DavidDT said...

grabbed bunch of UNG Oct10 calls @.725 avg - nothing I can not afford to lose - lots of buy signals on my charts

Enjoy Gas said...

It may be worth noting that the energy content of a bbl of crude is about 6 billion BTUs. 1000 cuft of natural gas contains about 1 billion BTUs. Therefore buying gas at $2 per 1000 cuft is equivalent to buying crude at $12/bbl. Both of those price levels are unsustainable since neither new gas nor new oil can be produced at those prices and any supplies currently available at those prices will soon be depleted. Unless you think oil will drop and stay well under $25 / bbl, it would be unreasonable to think that NG will stay below $2 per MMCF.

Gas is natural ... enjoy it!