Oil and Natural Gas Divergence - Actionable?

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Includes: OIL, USO
by: Cam Hui, CFA

Natural gas hasn’t followed the rally of crude oil. Even as crude oil approached $100, natural gas languished in the $7-8 range, compared to the highs of $14-16 seen in late 2005. The accompanying change shows the ratio of the price of natural gas to crude oil futures - click to enlarge:

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I have used the 12-month strip as the reference prices (1/12th the front month + 1/12th the 2nd month + … + 1/12th the 12 month future) as natural gas prices can be seasonal. The chart shows that natural gas prices are probing new lows against oil prices.

A look at the Commitment of Traders data from the CFTC shows a very different kind of story. Commercial traders, who are usually thought of as the “smart money”, are excessively long natural gas and giving a bullish signal. On the other hand, the signal from the COT data for crude oil can be best described as neutral.

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As a former trader I can attest that all these fundamental and sentiment signals don’t matter until they matter. Others have traded successfully on COT data but I have found them problematical as a timing tool. These conditions have persisted for several weeks. Just because these conditions are at extremes doesn’t mean that they can’t get stretched further.

In future posts I will examine other interesting divergences in the energy and energy related markets.