Universal Secret Hiding In The Gas Futures Market

by: Oil & Energy Daily

Following the recent brutal cold snap in the United States (with a similar one now kicking off in the Midwest and Northeast), natural gas prices are moving higher again.

It's like shooting fish in a barrel for short-term traders, who are simply positioning themselves alongside the trend.

However, before you go placing your bets on much higher natural gas prices over the longer term, it's essential to look at the futures market.

Why? Because there's a key question that only the futures market can shed light on. That is, are natural gas supplies running lower than expected, or is demand running higher than expected?

(Hint: investors betting on the upside for natural gas had better watch out.)

Look to the Futures

While the mere mention of the "futures market" sends anxiety through some investors, it contains vital information for commodity investors.

The futures market is basically an arena where you can buy, sell or hedge commodities. For instance, natural gas producers sell futures contracts at specific, predetermined prices to guarantee that their production will be sold. These prices are set by the market and can be higher or lower than the current price (also called the "spot" price).

It stands to reason that if a commodity is in high demand, prices should move much higher. This often prompts producers to generate more of the commodity to be sold at these higher prices. By locking in prices with futures contracts, commodity producers can smooth their earnings and hedge all, or part, of their production against a market downturn.

Sounds sensible, right?

Well, it isn't completely risk free…

When Hedging Goes Wrong

When a company sells futures contracts at a certain price against its production, it's then obligated to sell at that predetermined price, no matter whether the spot price rises or falls in the meantime.

So if there's an upturn, it could mean giving up any extra profits.

For instance, when gold was in the early stages of its massive upward run, most gold producers discontinued their hedging programs to take advantage of spot prices instead. Prices were barreling higher every day.

That decision made management teams look like geniuses.

Then the music stopped.

When gold prices plunged over a short period of time, the very few gold companies that did hedge their production in early 2013 were making out like bandits. The spot price has now fallen below what they've committed to pay.

The lesson here: Make sure you get futures information for all commodities - because it can make or break you.

Here's where to go…

Know the Game

You can get futures information from a variety of sources, but the easiest place to go is Yahoo Finance.

For example, if you look at the natural gas market, you can see the recent run, as the spot price has traded close to $4.50.

However, a closer look at the futures market would show that natural gas prices are actually trading at lower levels after the spring - when the winter heating season is over and demand subsides until the summer cooling season.

So you can see that while the current move in natural gas is real, there's no "super spike" on the horizon.

That's how I can tell that high natural gas prices aren't here to stay.

And "the chase" continues…

Karim Rahemtulla

Disclosure: I 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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Oil & Energy Daily is a team of financial researchers. This article was written by Karim Rahemtulla, one of our financial researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.