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Stock, Options, ETF and Commodities Investor; My educational background is in Computer Science and Accounting with significant entrepreneurial and Fortune 100 Corporate experience in Information Management and Technology services in industries including: Consulting, Oil and Gas, Manufacturing,... More
  • DGAZ - Buying On Dips 16 comments
    Feb 16, 2014 6:31 PM | about stocks: DGAZ

    For those who have joined in on DGAZ, these are interesting times and from here, we are all looking for the DGAZ bull. Natural Gas bulls once again took control last week. I've had some questions from several readers who are concerned about low storage levels of NG and how that might affect prices. Lets take a look at some of the dynamics, check where we are on some of the charts and see what we think still lies ahead for us.

    First, on the EAI website, I found the following Supply/Demand model for Natural Gas.

    Supply:

    The graph above covering from early last year through to roughly the current day, reflects how Natural Gas supply tends to remain relatively constant over time, with a mostly steady trend upwards. YoY, I read that last year, Production increased about 2% YoY.

    Demand:

    Demand over a year tends to fluctuate with much more volatility than supply, which is addressed with Natural Gas storage. You can see in the chart that during the cold winter months, demand spikes above the production supply so in order to meet demand during this time of year, withdrawals are taken from the many Natural Gas storage reservoirs throughout the US. The EIA site has tremendous information about the storage, growth in storage capacity, locations of the storage and types of storage if one is interested in going deeper into this portion of the story.

    During the spring and summer months, demand falls below supply, a situation that normally reduces prices, and during this time, injections to storage are made in order to prepare for the next winter season demand spikes.

    Storage:

    Storage of natural gas provides our national network with load balancing relative to demand and ensures stable supply provides our businesses and residences with instant on power when we need it, avoiding disruptions in service.

    Relative to understanding the dynamics associated with storage, lets look at the owners of storage facilities. Owners of underground storage for NG can include the following:

    - Interstate pipeline companies

    - Intrastate pipeline companies

    - Local Distribution companies - normally own the pipeline networks that extend to residences and businesses as end-users of Natural Gas services

    - Independent storage providers

    Supply and Demand Market forces

    NG Exploration and Production companies clearly have an interest in maximizing the price of Natural Gas they receive /mmbtu of production they sell to NG marketing companies. Because of the tremendous supply that has been discovered along with new fracking technologies used in our shale zones, NG saw some of the lowest prices in many years within the last 2 years, briefly trading below $2/mmbtu and having traded for a significant amount of 2013 just over $3/mmbtu. As a result of the abundant NG reserves in these shale zones, the rapid accessibility to supply, a number of E&P companies shifted their strategy to focus primarily on Crude Oil. This helped to stabilize prices a bit for those continuing to produce significant volumes of Natural Gas.

    Storage Capacity Owners - Following a very mild winter at the end of 2012 and going into 2013, storage operators may have been more reluctant to build up the volumes of storage to levels of full capacity, despite low prices of Natural Gas. As one can imagine, the storage operators thrive on the cold winters to bring a premium to NG prices withdrawn from storage to help cover carrying and operating costs associated with management of the NG Storage. So, starting the winter season with relatively low storage levels, combined with a harsh winter season throughout the US, we have found ourselves in a position where demand has been greater than previous years and we have withdrawn more from storage than previous years resulting in storage levels significantly below the 5-year and 10-year averages. A chart below from the EIA site shows our current position.

    With knowledge of these things in the background, I think this will help to look at our current situation and think about what is ahead for Natural Gas prices and for DGAZ.

    Natural Gas Pricing this winter

    Natural Gas Prices have moved from around 3.4/mmbtu in early November, to more than 5.7/mmbtu on the recent spike in early February and closed on Friday at about 5.2/mmbtu. It is both the very high demand, the significant withdrawals and low storage levels that in my analysis, have driven Natural Gas prices up as much as they have - roughly 68% based on Natural Gas CME spot prices. Spot price distribution in the Northeast and other parts of the country have at times, seen much higher temporary prices.

    My theory is that, having experiences these extremes in demand and the storage portion of supply and being at low supply levels, is the perfect storm that has caused NG prices to spike. But, I also believe is what will lead us to lower NG prices in the near future, as demand drops rapidly and storage withdrawals come to an end for this winter season and we begin to shift into the injection to storage season.

    Storage operators don't want to pay high NG prices to replenish storage capacity they will have to carry over summer and fall months until we return to next winter withdrawal season. While they may be at low storage levels, I believe they will wait until NG prices fall before they purchase NG for injection into their storage facilities. Considerations will be there of course on forecast of NG prices and if the prices are expected to rise significantly, especially going into next winter season, storage operators may have some level of higher prices for purchase baked into their economic modeling.

    From here, lets take a look at the Natural Gas Chart:

    (click to enlarge)

    (click to enlarge)

    A quick glance at this chart and it certainly appears NG is on a big bullish trend and that prices could be headed higher. Bullish action has included:

    - 50 day MA crossover the 200 day MA back in December and current prices well above the 50 day MA

    - MACD has trended since December with higher highs and higher lows - a bullish indicator

    So, on this basis, one could make the argument that we are headed for even higher prices on NG. So, lets look for any weakness that may exist in the argument to see if my theory has any support.

    Studying RSI, we will see that RSI showed NG was in an overbought state in mid-December (RSI well over 70), and we had a correction in prices. Again, we hit an overbought position in late January and RSI is now trending lower. You will also notice that Volume is trending lower from late January to present. I think these are the indicators that represent where we are headed in Natural Gas. While possible we may see further price spikes, I think we are getting closer to the end of the spikes and already are beginning to see lower highs and lower lows. In fact, with the last major storm and a large storage withdrawal that exceeded estimates this week for the prior week, NG spiked but did not manage to even get back to the 3.4 level from an early spike, much less the 3.7 spike. From here, I expect this chart to break down and become more bearish in the near future.

    Lets now look at an updated DGAZ chart.

    (click to enlarge)

    (click to enlarge)

    Despite the spike in NG prices this past week relative to the significant withdrawal on storage and the storm in the Northeast, this chart is still bullish. We received the MACD bullish crossover on Feb 10th and it is trending upwards, despite the price pressure.

    Volume while it pulled back from peak, is still very strong for DGAZ. RSI is at 37.63, not showing we are oversold, but definitely at the low end of the range which shows we have some significant strength to gain here in the near future, especially if the NG price starts to fall down.

    Conclusion:

    Abundant access to US Supply should continue to pressure NG prices lower in the next few months, especially as demand falls and we work to the exit of storage withdrawal season to meet demand. Low levels of storage, while a concern going into preparing for NG pricing next winter season, I do not expect to drive storage capacity owners to have a desire to pay what they model as high prices. They will look for lower prices before beginning substantial injections to replenish storage at levels that will be profitable for them to carry.

    While low historical storage levels will provide a little extra demand during injection season, my expectation is that this will have a small upward push on Natural Gas prices. My earlier projections were that during the next few months, we may see Natural Gas prices return to the range of 3.6/mmbtu. Perhaps the additional storage demand will hold prices up some and not quite achieve these levels. But, my anticipation is that will should come close to this level.

    That being the case, I believe we have quite some room to run in DGAZ from current levels as mentioned in my prior articles on DGAZ. If my thesis is correct, I think we should begin to see lower NG prices in the next week or two and continuing as demand continues to fall. If this price action does not show up in the next several weeks, then I may have to re-evaluate, but for now, I believe we will be headed to lower NG prices and higher DGAZ here very soon.

    Disclosure: I am long DGAZ.

    Additional disclosure: I also am long BOIL puts. I may trade and reposition DGAZ shares based on dynamics associated with the Natural Gas Market. I may also trade in and out of UGAZ, or buy/sell calls and puts on BOIL or KOLD (2X Leveraged ETFs on Natural Gas Index).The thoughts and opinions in this article, along with all stock talk posts made by the Author, are my own and are shared on the basis of helping others learn, to provoke other points of view that help us all on our journey to become better investors. My posts are never intended to provide investment advice. Investors should always view multiple sources of information in their due diligence process.

    Stocks: DGAZ
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Comments (16)
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  • Growfast
    , contributor
    Comments (273) | Send Message
     
    Author’s reply » Right after posting this article, I see the Asian markets opened trading NG at over 5.4. If we open near or above that level on Tuesday in the US markets, I would view that as a buy on the dip opportunity in DGAZ, aligned to the heading on this article - for those who believe my theory on lower prices ahead for NG.
    16 Feb, 06:56 PM Reply Like
  • yliu54
    , contributor
    Comments (170) | Send Message
     
    Thanks for the analysis. What I am worrying about is shorting NG is getting crowded.
    16 Feb, 07:13 PM Reply Like
  • Growfast
    , contributor
    Comments (273) | Send Message
     
    Author’s reply » yliu54 - What kind of effect do you think a significant short interest in NG will have on DGAZ? Might it provide some better opportunity to buy DGAZ cheap when short squeezes occur on bullish runs by exaggerating them?

     

    Do you think it will keep NG from hitting lows or DGAZ climbing to highs?
    16 Feb, 09:02 PM Reply Like
  • Never Again
    , contributor
    Comments (6) | Send Message
     
    Awesome analysis Grow! It provides some hope based on scientific
    Reasoning.
    16 Feb, 09:34 PM Reply Like
  • $DUST
    , contributor
    Comments (51) | Send Message
     
    Where do you expect DGAZ to top off? How long do you expect it to be bullish?
    16 Feb, 09:35 PM Reply Like
  • Growfast
    , contributor
    Comments (273) | Send Message
     
    Author’s reply » DUST - From my analysis and with some assumptions of course, I think we should see the 10-12 levels on DGAZ before our summer months, with a more conservative range being 7-10. DGAZ may remain somewhat bullish through the summer months, but toward the fall, I believe the fundamentals will shift back in favor of bullish NG.
    17 Feb, 10:58 AM Reply Like
  • $DUST
    , contributor
    Comments (51) | Send Message
     
    Thx for all the info. Keep up the great work!
    17 Feb, 01:00 PM Reply Like
  • losingbeta
    , contributor
    Comments (8) | Send Message
     
    great analysis, but while I was bearish on NG I've now switched to a bullish position. DGAZ/UGAZ rolled to April contracts last week and there's a lot of room for it to rise and close the gap to current spot prices. Historically you've seen NG take very protracted annual moves. It certainly feels as though natural gas wants to go up this year, and the very cold weather that hit the country this winter was just the impetus it needed. Low storage levels will keep prices high. The game is cooked, and this is the narrative we'll hear all year to justify the higher prices. Also, as uncertainty looms with the stock market, more and more investors seem to be moving money into commodities. It's hard to want to get in front of this moving train.

     

    Based on the charts, I think we'll continue to go higher to a little above $6 and then pull back a bit before trending even higher.
    17 Feb, 06:16 PM Reply Like
  • Growfast
    , contributor
    Comments (273) | Send Message
     
    Author’s reply » losingbeta - Nice to hear a view from the "dark" side. The dynamics at work are definitely very interesting at present. We have not yet rolled into the April contract, as expiration for March is on 2/26. It is going to be very intense here in the next week or so as the bulls and bears wrestle.

     

    Bulls as you suggest are looking at the higher spot prices, take Henry Hub at $7 last week and driving NG March futures in that direction. I think Henry Hub prices are going to fall off a cliff this week as southern weather has moved most to completely turn off the heat and open the windows. And, April contracts are priced for the fall and resisting going up to what they see as temporary.

     

    If you bulls do get us to 7, that should be a good buy on DGAZ for sure! Low storage will keep prices from going back to 2, but I'm not so sure they will hold us up anywhere near current levels when demand falls off the cliff in March and April. Just as fast as the prices went up, they can come back down. But, I could always be wrong.

     

    If market manipulators can truly manage these markets to where they want to go, then I will be out of look in the end on this. But, I am eager to see how this is going to play out. Lets check back in with each other following the storage report release on Thursday morning and see what things look like from there.
    17 Feb, 06:25 PM Reply Like
  • losingbeta
    , contributor
    Comments (8) | Send Message
     
    Actually DGAZ / UGAZ which track the S&P GSCI Natural Gas Index Excess Return, rolled over to April contracts over a 5 day period ending 2/13. I'll have to dig up the info, but even UNG ends its rollover to April contracts tomorrow which is easily accessible on their website. I'm sure you've noticed that DGAZ / UGAZ haven't been tracking March contracts well the last few days. That's because it's switched to April.
    17 Feb, 07:27 PM Reply Like
  • losingbeta
    , contributor
    Comments (8) | Send Message
     
    Here's the UNG info. http://bit.ly/LwDPOs

     

    GSCI roll date starts on the 5th business day of the month and lasts 5 days (so 2/7 to 2/13).

     

    Be careful. Without knowing these things, you're trading blind.
    17 Feb, 07:39 PM Reply Like
  • Growfast
    , contributor
    Comments (273) | Send Message
     
    Author’s reply » losingbeta - thank you for highlighting this as I was actually thinking in terms of watching more closely the Mar/Apr spread to consider a repositioning move. I read through much of the document initially on the S&P GCSI NG Index, but missed the roll period explanation buried in the long document. I've just reviewed that and now not worried about contract expiration or the spread.

     

    This will help me in go forward considerations for repositioning.
    18 Feb, 10:50 AM Reply Like
  • $DUST
    , contributor
    Comments (51) | Send Message
     
    So how does this affect the aforementioned? I'll admit I find these particular stocks a bit confusing. Usually trade gold, but want to diversify into other commodities (i.e. energy), however, still trying to get my brain around all the indicators and how should I read them. Any advise/info is appreciated.
    18 Feb, 01:22 PM Reply Like
  • Growfast
    , contributor
    Comments (273) | Send Message
     
    Author’s reply » DUST - It is one factor of several various factors to consider and to be aware of. At this point, it does not change my thesis, nor my targets and I will continue to evaluate.

     

    ETF's against futures contracts are going to roll one way or another month to month. And, pricing can be in cantango or backwardation. The rolling effect can cause premiums or decay in the pricing of the ETF's when looking at NAV, but the roll methodology also smooths the roll - which is better than if contracts just rolled over at expiration in the even there was a big spread in pricing from the front expiring month to the next month. Volatility can also cause decay in NAV. So, good to have awareness and consider the effects on any buy, hold or repositioning plans.

     

    When trends develop strongly however, premiums in market pricing versus NAV can separate significantly and that can trump a good deal of the premium or decay associated with NAV. With the 3x leveraged ETF's, the trend can really be your friend - more so than one will calculate in NAV.

     

    We missed the opportunity to reposition, if we wanted to, during this last contract roll, which is done in business day 5 through 9 of a new month. We already made the transition from the higher priced March contract to the lower priced April contract. I have not yet gone back to calculate, but want to go study to see how much pricing we lost in those days during the roll period. If insignificant, then we didn't miss much opportunity. If it was significant, in future cases where the spread is large, it just might be favorable to see the ETF ahead of the roll and buy back on completion of the role if all fundamentals are in order. That is, unless premium on NAV is running with the trend over-riding the effects of the roll.
    18 Feb, 01:37 PM Reply Like
  • Rock_nj
    , contributor
    Comments (529) | Send Message
     
    Can you please update your outlook for DGAZ given that the March nat gas contract hit $6.40 and the April contract is around $4.80 and May is around $4.65. Isn't there a chance that Nat Gas falls back to $4.65 by the time the May contract is the front contract, but DGAZ longs see little benefit since that's where the contract it will be holding in about 2 weeks is trading now?
    21 Feb, 06:33 AM Reply Like
  • Growfast
    , contributor
    Comments (273) | Send Message
     
    Author’s reply » Rock_nj,

     

    On the basis of NAV, this certainly seems to be a possibility, that the current contract pricing as we roll month to month, if already pricing for lower NG prices, and prices do not come down further, we may not see significant movement in DGAZ NAV. Pricing on the strip has turned out not to be a significant advantage for DGAZ.

     

    In prior moves on DGAZ, there has not only been the increase in NAV when the trend works with you, but the gain in price/NAV, similar to how in a positive market for stocks, one can see P/E expansion.

     

    In a prior move, DGAZ moved over 110%, while NG moved about .80, but I don't have a view of how contracts were priced at that time to know how that factored in. I will continue giving thought to this and work to incorporate into additional analysis.

     

    In the meantime, one way to hedge this, might be to buy some calls on BOIL or sell some puts on KOLD to see if that side of the trade turns out to take in some benefit.

     

    Thanks for the input. More to come.
    21 Feb, 09:44 AM Reply Like
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