Oil and natural gas have been very hard to trade in recent months. The fundamentals that underlie both of the commodities are both complicated and volatile. And if that wasn't enough, there is also the uncertainty about whether prices are moved around by actual fundamentals or just by traders and speculation.
However, combining the two commodities through the associated ETFs might yield a relatively lower risk trade and a good profit. In my opinion, the profitable way to combine the two commodities would be to get long oil (USO) and hedge it with a natural gas (UNG) short.
UNG has experienced a 14% rally on June 14th 2012. That huge move has somehow complicated the analysis of how to trade natural gas. My suggestion is to disregard such erratic moves that deviate from the main trend. Natural gas has made some strong short-term rallies but has failed to establish an upward trend. Some investors argue that the fundamentals of natural gas have improved and the latest daily upside move was a result of that. I would argue that the natural gas price has been moving so erratically that there is no amount of fundamental changes that can justify such huge moves on such short-term basis. Natural gas is a purely speculative investment, in my opinion, and will remain so until it experiences a capitulation bottom. More details about my natural gas analysis can be found in this article:
I would argue that the short-term moves in natural gas and hence UNG should be discarded. Instead, here are some reasons why the USO and UNG trade suggested above would be a profitable one:
- The contango in the natural gas market is a lot higher than the oil market. Therefore the losses to contango that UNG suffers are a lot higher than USO. Because of that inherent disadvantage the above combination has a positive yield.
- Oil is positively correlated to market sentiment and does rally when market sentiment improves. Natural gas rarely benefits from rallying markets and usually keeps its downward trend. This should make the above trade very profitable if the Eurozone situation improves.
- Oil seems to have bottomed around $80 as it does not go down excessively when the market sentiment goes down.
- Natural gas has recently failed in its attempt to rally. Failed rallies are very negative indicators for medium-term trends.
- Oil at $80 seems to be accepted as a very reasonable level for the commodity by the investors. However, similar kind of a consensus does not exist for natural gas even though it is very cheap. For the purposes of investor sentiment, that puts natural gas at a disadvantage to oil.
This trade should be profitable until late July 2012, in my opinion. I will try to post a follow-up article to this trade by late July 2012, about whether the trade has been profitable and whether the profits should be realized.
Investors who find that my trading suggestions and analysis are of good quality can use the "Follow" feature of SA to get that follow-up article.
Disclosure: I am long USO. I am also short UNG through July 2012 put options.