Natural Gas: Are We Getting Overbought?

| About: The United (UNG)

Summary

Natural gas prices have soared 20% over the past 2 weeks.

Bullish sentiment on natural gas has shifted from bearish to bullish, but is nowhere near exuberant levels.

While we could see short-term profit taking, the trend in sentiment supports higher prices.

Just two weeks ago I wrote an article about natural gas (NYSEARCA:UNG) and discussed why the odds were significantly in favor of the bulls. Since the article was published, natural gas has exploded higher from $2.73 to a price of $3.31 today. In my November 16th article I said this:

"In summary, I would like to see natural gas bulls climb back above the 30% level, and above the 21-day sentiment moving average. While this is not my textbook buy signal, it will put momentum back in the bulls camp. The strong support at $2.55 is support until it's not, and I expect bulls will defend this level going forward. I will be watching natural gas closely over the remainder of the week, and may enter a long position if my secondary buy signal shows up based on my DSI moving average system."

The sentiment buy signal I referenced in the article was completed on November 18th, and the commodity has had significant momentum behind it since. Despite this violent rally in natural gas prices, sentiment is not overly enthusiastic. Natural gas bulls currently sit at the 60% level, up from 27% bulls on November 15th. This means that despite a 20% rally in natural gas prices, we have only seen 33% more bulls come into the commodity. To put this in perspective, copper gained 20% between October 28th and November 25th, and copper bulls moved from 28% to 90%. This means that for every 1% gain in the price of copper, bullish sentiment increased over 3%. This significantly differs from natural gas where every 1% increase in the price of natural gas, bullish sentiment only increased by 1.6%. In my opinion this shows disbelief or skepticism in the recent rally, as a significant amount of market participants have still not been converted to bulls.

Click to enlarge

(Source: Investing.com)

Due to the sentiment buy signal on natural gas on November 18th, I went long natural gas at $2.84. I am currently up 15% on my position, and my first stop on this trade is on a close below the 50-day moving average. The 50-day moving average for natural gas currently sits at $2.97, which means my open position will lock in just under 5% per share if this level is breached. I have placed my stop below the 50-day moving average, as this is my short term momentum level for commodity trades. Due to the fact that my stop is on a close below the 50-day moving average, this means it is not a static stop. This stop is instead a trailing stop, and will adjust at the close of each trading day.

Click to enlarge

(Source: Investing.com)

My stop for the remaining half of my position is on a close below the $2.55 level. I believe the $2.55 level to be of significant importance as it coincides with very strong support, and the 200-day moving average. I believe as long as natural gas remains above its 200-day moving average, there is no reason to question the bull case. My stop at the $2.55 level is a static stop, as I am also using the strong support at $2.55 as my stop level.

Click to enlarge

(Source: Investing.com)

Sentiment

I have built sentiment charts with data from the past 20 years in order to help readers better visualize what sentiment on different asset classes currently looks like. Looking at the below chart, we can see what natural gas sentiment data looked like at the time of my most recent article. As we can see bullish sentiment was attempting to form a bottom after closing above the 5-day and 10-day sentiment moving averages. At the same time, natural gas prices were sitting on a rising trendline, as well as being just above horizontal support at $2.55. In the article I mentioned that I wanted to see bullish sentiment on natural gas (white line) close back above its 21-day moving average (red line) before establishing a long position.

Click to enlarge

(Source: Daily Sentiment Index, Author's Chart)

Chart Legend - White Line: Natural Gas Bullish Sentiment, Blue Line: 5-Day Moving Average, Green Line: 10-Day Moving Average, Red Line: 21-Day Moving Average

Click to enlarge

(Source: Daily Sentiment Index, Author's Chart)

Chart Legend - White Line: Nat. Gas Bullish Sentiment, Blue Line: 5-Day Moving Average, Green Line: 10 Day Moving Average, Red Line: 21-Day Moving Average

Taking a look at the above updated chart, we can see that the sentiment chart has made many positive developments. The 5-day and 10-day moving average are now closely following bullish sentiment, and bullish sentiment is back above all 3 of its key moving averages. In addition to this, the 21-day moving average has now swung positive, and is trending higher. This is great news for natural gas bulls, as typically dips to the 21-day moving average are bought. As we can see in the April to July rally, the 21-day moving average provided strong support on several different occasions. Any dips to this level were bought with both hands by investors, and it took a bullish sentiment reading of 87% to finally subdue the rally.

Technical Outlook & Summary

Taking a look at a daily chart of natural gas, the short term trend has flipped back to bullish. Natural gas is back above its 50-day moving average, after shaking out most of the bulls in early November. While most bulls were running for the exits in natural gas at $2.55 a share due to the massive decline from $3.30, price was sitting right at support.

Click to enlarge

(Source: Investing.com)

One of my favorite quotes from Peter Brandt is as follows:

"A common trader mistake is bailing out of the position on a minor correction that has no technical significance."

I believe this to be very true of the recent pullback in natural gas, as very little technical damage was done. While there is no doubt the correction was violent and swift, price was sitting on three different support levels when all the bulls were throwing in the towel. The sentiment reading when natural gas touched this level was 25% bulls, down from a bullish sentiment reading of 87% bulls at the October top. I believe this correction was very positive for bulls still in natural gas, as it gave sentiment in the commodity a chance to reset itself.

In addition to natural gas being back above its key moving averages, it also made a marginally higher high today. The October rally topped out at an intraday high of $3.366, and today price made a slightly higher high at $3.367. While I would have preferred a close above this level for confirmation, natural gas still made a slightly higher 52-week high. New highs are always bullish in my opinion, and the fact this occurred with only moderately bullish sentiment is a plus.

In summary, I do not see any reason to doubt this natural gas rally just yet. Natural gas bulls are only at the 60% level, and we could easily see a run to 80% bulls or higher before things get toppy. Having said that, I am open to seeing some profit taking in the commodity. Natural gas has just risen 20% in a month, and I would not be surprised to see a minor pullback. Being a trend follower I position myself for the big swings, and have no interest in selling here, and trying to buy the dip. If there is no dip until higher prices I will be selling a commodity with significant momentum behind it, and if there is a dip there is no guarantee I will be able to catch it. I have no interest in trying to predict the next 2-3% move in natural gas, but believe the next 5-10% move is likely higher. I will not be shaken out by mild profit taking, as my stop remains at the 50-day moving average on a close. As long as price continues to close above the 50-day moving average, I will remain long a full position in natural gas.

For those long natural gas with a short term time frame, taking partial profits may not be a bad idea, but I would not be peeling off more than a half position. Ultimately I would not be surprised to see $3.50 or higher on natural gas as sentiment is nowhere near exuberant. The current up-trend in sentiment is still just maturing as it sits at the 60% level, and should continue to fuel this current rally going forward.

Disclosure: I am/we are long UNG.

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: If you liked this article and found it useful, please feel free to follow me by clicking on my name next to my avatar at the top of this article. I also invite you to follow me at www.twitter.com/TaylorDart01 where I routinely share my entries, exits, and stops on new positions, as well as updating followers on sentiment data on markets I am following.