Bullish Divergence in Natural Gas

Recently the Natural Gas markets have been extremely volatile. Within the past 3 months we have witnessed more than a 25% swing ranging from the highs to the lows. During the past few weeks natural gas prices have been consolidating around the $3.75-$4.00 range. This consolidation phase prompted a bullish signal with the winter ahead of us. After reviewing some trends, I believe that natural gas prices are poised for a move higher in the short and long term time frames.

Fundamental Analysis:

After browsing various meteorological sources, I found a video of Accuweather's Chief Meteorologist and Expert Long Range Forecaster, Joe Bastardi, whom has released an early prediction for the 2009-2010 winter. He is predicting a very cold winter for the upper NE between Washington D.C. and New York City. This winter could possibly bring the coldest and most severe conditions the region has witnessed in the past 5 years.

This forecast seems to follow the general trend of predictions from most of the local meteorologist within the region. If the forecasts are proven to be correct, natural gas prices could increase by more than 25%.

Technical Analysis:

With the hottest part of the summer approaching and the winter months ahead of us, natural gas prices are poised to increase. After analyzing the 10 day chart of UNG, I have noticed that there was a sign of bullish divergence forming between UNG and the Relative Strength Index, RSI, technical indicator.

For those not familiar with technical indicators, the RSI compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.

After analyzing the indicator in conjunction with the security, I noticed a discrepancy in the trends. As UNG makes multiple weekly lows, the value of the RSI makes higher weekly lows. This is an excellent example of bullish divergence. Bullish divergence occurs when the security prices falls to a new low, but the oscillator makes a higher low and fails to make a new low. When an oscillator displays the following pattern described above it means that there is more buying pressure than selling pressure at the given price.

If the short divergence above proves to be valid, UNG prices could appreciate as high as $14 within the next week.

The following chart is a 3-month chart of UNG:

As highlighted in the chart above, the prices currently reside on strong support levels. Not only are current prices at a key trendline support level and at the 200 day Moving Average support, we are currently positioned at the 23.6% Fibonacci Retracement level.

For traders not familiar with the Fibonacci retracement tool, the retracement tool is used in technical analysis to reflect the probability of a security to retrace to that of the original amount. The Fibonacci levels are created by drawing a trendline between the highest and lowest points of the security (in that time frame) and then dividing the vertical distance by the key Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.

These key support levels mentioned act as technical barriers that need to be overtaken before UNG can expect a positive price movement. If UNG were to move upward, using the 200 Day MA as firm support, UNG could rally as high as or higher than $15.

Disclosure: At time written, author did not own any securities of UNG, but looking to accumulate option calls in the near future.

Comments

[kmi:]

Ouch... if you are betting on the weather... NE experienced one of its mildest summers ever, which some folks are blaming on El Nino, and suggesting El Nino will contribute to a milder than normal winter.

Maybe those indicators are accurate but I wouldn't bet on the weather to back you up...

Aug 10 08:30 AM

[skrangeo:]

aren't you the same guy who said that

A) the political disturbances in Iran would drive up NG prices because of Iran's vast natural gas reserves (LOL) and

B) the price effect on natural gas due to the american dollar (LOL x 2)


Now, to add to your resume of information, you saw a video of a meteorologist on Accuweather.


Solid

Aug 10 09:36 AM

[Mad Hedge F...:]

dfgg. I have been a growling, obnoxious, and highly unpopular bear on natural gas since I put out my sell recommendation on June 2 , just before the crash from $4.30 to $3.10. Since then it has been bouncing around like a ball bearing in a boxcar on the Durango & Silverton Railway. Devon Energy’s (DVN) CEO Larry Nichols has me wondering how long this exasperating action will continue, and when a recovery will begin, if ever. NG has been a screaming chart buy for months, but with terrible fundamentals. Thanks to advanced fracting technologies, hardly a week goes by without a major new find somewhere in North America, taking our reserves from nine years to 100 years in a New York minute. So the US is sitting on a gigantic untapped gas formation? Who knew? DVN, one of the best managed companies in the industry, has a balanced oil/gas portfolio. Fortunately, windfall profits in oil have offset wrenching losses in gas. By chopping NG exploration to nothing, it has halved its drilling budget, and that money has dropped straight to the bottom line, enabling it to announce great earnings. See my call to buy competitor Chesapeake Energy (CHK) before its unbelievable 250% run . Despite the prices not seen in a decade, gas demand from industry remains moribund. But Nichols thinks continued production cuts will bring the gas market into balance sometime this winter, making those charts a lot more interesting. Maybe you should be picking up some of the NG ETF (UNG) on its next dive down to $12.50.

Aug 10 12:07 PM

[Herman Hemati:]

That is a good point... I'm averaging down if it does dip.

I see UNG above $15 by winter though.


On Aug 10 12:07 PM Mad Hedge Fund Trader wrote:

> dfgg. I have been a growling, obnoxious, and highly unpopular bear
> on natural gas since I put out my sell recommendation on June 2 ,
> just before the crash from $4.30 to $3.10. Since then it has been
> bouncing around like a ball bearing in a boxcar on the Durango &
> Silverton Railway. Devon Energy’s (seekingalpha.com/symbo...)
> CEO Larry Nichols has me wondering how long this exasperating action
> will continue, and when a recovery will begin, if ever. NG has been
> a screaming chart buy for months, but with terrible fundamentals.
> Thanks to advanced fracting technologies, hardly a week goes by without
> a major new find somewhere in North America, taking our reserves
> from nine years to 100 years in a New York minute. So the US is sitting
> on a gigantic untapped gas formation? Who knew? DVN, one of the best
> managed companies in the industry, has a balanced oil/gas portfolio.
> Fortunately, windfall profits in oil have offset wrenching losses
> in gas. By chopping NG exploration to nothing, it has halved its
> drilling budget, and that money has dropped straight to the bottom
> line, enabling it to announce great earnings. See my call to buy
> competitor Chesapeake Energy (seekingalpha.com/symbo...)
> before its unbelievable 250% run . Despite the prices not seen in
> a decade, gas demand from industry remains moribund. But Nichols
> thinks continued production cuts will bring the gas market into balance
> sometime this winter, making those charts a lot more interesting.
> Maybe you should be picking up some of the NG ETF (seekingalpha.com/symbo...)
> on its next dive down to $12.50.

Aug 10 12:23 PM

[whidbey:]

I want you to be right, I ate some HGT and it is making me ill.

The Obama policy has not nodded to NG as yet, it will not do so until the coal fired are forced to dual fuel plants, and maybe autos burn NG. I think it is a while off, like years, but I have time and no body wants my stock--yet.

Aug 10 12:26 PM

[Herman Hemati:]

The link to the meterologist did not publish. Please reference:

link.brightcove.com/se...

Aug 10 07:27 PM

[Northstar10000:]

Autos do burn NG now, Utah has the highest use of NG vehicles in the country. It's a lot of common folks who own them not just corporate do gooder show offs with there NG company cars. There is a market, infastructure and a cultural bias to drive, buy and use the things. There is actual a big market to get used NG cars shipped to Utah. Got a friend in the business out there and he can't ship them fast enough. It's honest to goodness boom going on and no one talks about it. Probably an anti carbon bias thing.

Aug 10 10:30 PM

[Mad Hedge F...:]

zxcv. I ran some numbers today and came to the staggering conclusion that at $3.60/BTU, natural gas is now cheaper than coal in some markets. One ton of high grade Pennsylvania anthracite costs $65/ton. Some 18 million BTU’s of natural gas, the energy equivalent, costs $66, and doesn’t give you black lung, asthma, lung cancer, polluted air, and mountains of ash. The BTU equivalent of crude comes in at $210, and high test gasoline at an extortionate $420. The crude/NG ratio is at 19:1, an all time high, and an entire generation of ratio traders has been wiped out. It’s just another one of those six standard deviation events which seem to be happening constantly. And like a rubbernecker driving past a gory accident where the human organs are draped over the detailing, I am always interested in wipe outs. Yes, I saw the movie Crash. Don’t ask. Why aren’t the power companies jumping in and burning gas instead of coal? There is the minor issue in that the industry needs $500 billion and ten years to build the plants to take advantage of the enormous new supply. So only frenetic production cuts will support the price until then, which are accelerating as you read this. Or a major hurricane. Better keep UNG on your screen and buy the next wash out.

Aug 10 11:50 PM

[bertil:]

Thanks for the weather link - it is indeed insightful! What it means for UNG is not so clear. There is something not so logical going on here. With all the noise about independence of foreign oil when we have this super abundance of NG....

Aug 11 08:57 AM

[dieuwer:]

Is there not a HUGE naked short position in UNG?

Aug 11 03:01 PM

[dieuwer:]

Did some math on the October options.
Total open interest on calls is 388737, open interest on puts is 537213 with majority of options around $13-14. Smells like naked short indeed!

Aug 11 03:10 PM

[H. T. Love:]

On my 200 day chart, which I prefer with this level of uncertainty, things look different. Currently RSI 45.11, and not showing divergence, MFI 33.88 and both are trending down. MACD slightly down to neutral, A/D broke down towards neutral on 8/5 and stochastic looks like at least a few more days before a break up (that fits with the roll-forward beginning 8/13) awith %K @ 13.9 and %D @ 52.2%.

The killer is that since the high volume of Mon 8/3 (62.9MM shares traded) the volume has declined to 23.34MM as prices dropped. This *does* indicate a change coming, in isolation, but when combined with the other indicators, it can't be interpreted to mean it's ready to turn up.

We recently had a reversal gap up, but it could not break away and the gap was filled within 4 days.

Significant resistance at $13.50, even with the premium being seen. We're going to see some more days below $12.50 for the near-term. Every time UNG pops over $13.50, e.g. the recent brief foray to the intra-day high of $14.19 on 8/5, it heads right back down.

As I write this, the Nymex HH futures for Sep-Dec show $3.541, $3.812, $$4.655, $5.404. A few months ago the spreads were similar, although the price points were different. As each month becomes current front-month, it has consistently suffered price deterioration. They will continue to behave this way, I think, until far into the winter (haven't worked all the number yet, so this is a SWAG - Scientific Wild-Assed Guess).

Roll forward starts 8/13 and continues through the 18th. About two thirds of the time (examined over a six month period) price falls for the four days during which this is done. The changed nature of the UNG structure may affect this. Since this is the first time we'll see this situation, we have no prototype to use for comparison.

Technicals aside, because of changes in the composition of the fund, due to lack so far of SEC approval for more units (and appears unlikely to ever be granted for now), tracking of the underlying is uncertain. Further, the CFTC actions are limiting the positions UNG can hold in the NG futures market.

Since new baskets can not be "created" and "redeemed" by dealers, the units are now trading more like a normal stock and tracking error is evident already (NAV +4.14% premium at close of 8/10). This will correct at some point ... maybe. This is the *only* thing I see as a near-term *possible* upward impetus.

Rig counts down 58% from 8/29 and 9/12 peak to 681, but injections to storage still coming in higher than expected for the time of year.

When I combine these charts I developed

static.seekingalpha.co...

with my expectations of the economy, 19%+ storage over-supply (compared to 5 year average), expected reduced consumption for industrial use (per GDP estimates recently, only 65% capacity utilization), reduced drayage and transportation use (reduced ecomonic activity), consumer being squeezed and lowering/raising thermostats to save money, it would have to be one hell of a winter and in an area broader than just the northeast to make a dent in this scenario.

Since normal ratio of underlying to NAV is 1:3.45, to make $15, the underlying NG futures and OTC swaps that UNG must now purchase will have to work out to $4.35 NAV. EIA predicts that prices for NG will remain below $4.00 for the remainder of 2009.

Although I don't show them here, I have also constructed charts that show historical production/consumption and rig trends. I have to assume that the normal increase in winter consumption will be muted unless the increased severe winter weather is widespread.

Remember that UNG does not trade in isolation. It is still strongly connected to the actions of the underlying NG futures contracts, even if a larger portion is now in OTC swaps.

To summarise: I disagree. I think your article doesn't address the considerations properly.

Disclosure: long UNG short calls as a *trade*, not an investment. I make more $$ if UNG goes up, so my comments are counter to my best interests. But I saw conditions to make some $$ with this combination regardless of which way it meanders.

HardToLove

Aug 11 07:19 PM

[Gwhitebeard:]

Actually, NE experienced one of it's COOLEST summers!


On Aug 10 08:30 AM kmi wrote:

> Ouch... if you are betting on the weather... NE experienced one of
> its mildest summers ever, which some folks are blaming on El Nino,
> and suggesting El Nino will contribute to a milder than normal winter.
>
>
> Maybe those indicators are accurate but I wouldn't bet on the weather
> to back you up...

Aug 12 05:07 AM

[Shale Gas:]

Herman,

here's an interesting article on natural gas staying below $4 for years:

www.rigzone.com/news/a...

Aug 13 06:59 AM