Natural Gas From The Sidelines - Another Lesson From A Harsh Teacher

About: The United States Natural Gas ETF, LP (UNG), Includes: BOIL, DCNG, DGAZ, GAZB, KOLD, UGAZ, UNL
by: Andrew Hecht

I got out last week.

Removing cobwebs.

Inventories remain bullish.

What rally?

The long-term forward curve reflects fundamentals.

On Friday, January 26, I closed all of my long positions in the natural gas futures, and ETF/ETN markets. While the results were profitable, being bullish on the price of the energy commodity was less than fun and created months of aggravation since November. We tend to learn lessons from our most difficult forays into markets, and what I learned yet again, was that trading rather than investing in natural gas is the optimal approach to the volatile commodity that loves to punish those stubborn longs and shorts, like myself. After I canceled my price stop in December and opted for a time stop, which was the best call I made in the energy commodity, I felt like a mother hen sitting on a long position waiting for it to hatch. While I gave birth to a profit at the end of January, in retrospect, I could have made a lot more money trading back and forth from long to short over the period.

Last Monday, I watched the price of the now active March futures contract trade in a range from $3.038 to $3.186 per MMBtu. At the low, it looked like $3 would give way once again, but it rallied on the first day of last week. March futures closed not far from the highs that day, but the opportunity to grind profits from a 15 cents range turned me from hen to trader as I realized that getting rid of the long amounted to spring cleaning of the cobwebs in my head. Later in the week, the bottom fell out of the natural gas market as the price dropped by more than 40 cents from Monday’s peak.

I got out last week

The time stop for my long position in the natural gas futures market was the third week of January. I typically advocate developing a plan before entering into any trade or investment on the long or short side of a market. When I began buying natural gas in November and continued to add to the position in December I had initially set a price stop. However, when the price approached the level where I would usually bail out and lick my wounds, I decided that it was too early in the season and inventories were too low to throw in the towel on the market. In a move of utter stubbornness, which is never a good trait for a successful trader, I decided to move the stop to the third week of January or the end of the month at the latest. I realized that the initial limited risk foray into the volatile world of natural gas had become an open-ended risk that could become a nightmare if the price were to head towards the March 2016 low at $1.611 per MMBtu. Meanwhile, I got extremely lucky, and the recent rally bailed me out, and I was happy and relieved to close all positions by Friday, January 26.

Removing cobwebs

In retrospect, my experience in the natural gas market over the past three months reminded me that it does not matter how much experience one has as a trader or investor; markets continuously teach us lessons. When I look at the weekly chart in the natural gas futures market since November, the most recent tutorial courtesy of the energy commodity removed some of the cobwebs buried under my thick bald skull

Source: CQG

The weekly chart of NYMEX natural gas futures reminds me of just how sick I felt in late December when the price fell to only four cents above critical support at the February 2017 lows at $2.522 per MMBtu. My decision to move to a time stop was not a disciplined and cool-headed calculated move. It was inspired by frustration and anger which is never a good thing. I decided to throw my typical caution to the wind and take a shot.

Had I pulled the trigger at my original stop level which was much higher, I would have been in a position to take advantage of the fact that the price did not violate its technical support level. I would likely have made much more on the view that stocks were too low, and the price would rebound on cold weather conditions. However, like a deer in the headlights, I held my nose, closed my eyes, and hoped for a miracle. As I look back, I made a mistake that I will try not to repeat in the future. The mistake is that I forgot that the price of an asset is always the right price because it is the level where buyers and sellers meet in a transparent environment. It is far easier to objectively analyze a market without the bias of a wrong position. I was blinded by my directional bias and forgot that natural gas is a trader’s paradise and an investor’s nightmare and found myself wearing an investment position. It is a position I have found myself in many times during my career, and at times the results were ugly. This time, I was lucky.

Inventories remain bullish

Sitting on the sidelines last week, I critically analyzed the process that led to the unnecessary aggravation I subjected myself to for almost 90 days. I did not trade natural gas last week, as I promised myself I would take at least five sessions in the penalty box for my lapse in discipline, but I watched the price action like a hawk. When the price of March futures rallied on Monday, January 29, I shrugged my shoulders as I left some money on the table. Later in the week, I became grateful for the penalty and comfort of the sidelines. Inventories continue to be low for this time of the year, but they are doing nothing to support the price and any stubborn longs are now under immense pressure once again as the shorts are back in control of the market. On Tuesday, natural gas futures made a new high and closed on the lows of the session leading to a gruesome on Wednesday for the bulls. The consensus for Thursday’s stockpile data from the EIA was for a withdrawal of around 90 bcf from inventories.

Source: EIA

As the chart highlights, the EIA reported a slightly higher withdrawal than the market had expected on Thursday, February 1. The decline in stocks of 99 bcf compared to a consensus of 90 bcf did nothing to support the price. As of January 26, stocks of 2.197 tcf are 19.3% below last year’s level and 16.2% the five-year average for the energy commodity. With lots of winter to go, inventories are low and remain bullish while the price action is paying attention to the fourteen-day weather report that came out last Wednesday.

What rally?

The price action in natural gas since last Thursday, when the price slipped below the $3 per MMBtu level once again, has been uber-bearish.

Source: CQG

As the daily chart of March natural gas futures shows, the price declined from the highest level since November at $3.259 on January 30 to lows of $2.837 on February 1. Over a period of 72 hours, a warmer than average weather forecast and higher than expected inventory report results in a selloff of 42.2 cents per MMBtu or 12.95%. Over two weeks of the recent rally were wiped out in two days leaving anyone left holding the bag in the form of a long position to wonder, what happened to the rally and bullish price action? After punishing shorts with a rally that took the February futures above the $3.60 level at the end of January, natural gas turned its wrath on the longs once again. Inventory numbers were not bearish, but that was beside the point as Groundhog Day was Friday, pitchers and catchers report for spring training in less than two weeks, and the market will turn its focus on the end of the withdrawal season sooner rather than later.

The long-term forward curve reflects fundamentals

Despite the cold snap around the holidays that lingered into the beginning of 2018, it has been a warmer than average winter meaning that demand for heating is lower. However, with stocks at over 15% below both last year and the five-year average demand from power generation and LNG exports is likely taking up the slack in the market

Source: NYMEX

As the forward curve out to April 2021 illustrates, the price is flat with only some strength during the winter months of high demand in 2019, 2020, and 2021. While bears will argue that massive gas reserves will fill inventories quickly in the months ahead, the current price does not provide big margins for producers, and demand from power and LNG will remain steady in the months ahead.

After standing on the sidelines and watching the price melt before my eyes over the past week, I hope that we see a continuation of selling that takes the price south of $2.50 per MMBtu. I will be highly selective when it comes to buying, and I actually may dip a toe into the water on the short-side over coming sessions. However, I continue to believe that the odds will eventually favor the long side if the price can drop to a level where producers cut back on output.

When it comes to risk, natural gas is one of the harshest teachers in the world of futures. It taught me a lesson over recent weeks, and it probably will continue to do the same in the future. However, next time I will stick to my trading plan and stop out when the market tells me I am wrong. A time stop worked this time, but past performance is no guaranty of the future, and I got off easy with the taskmaster that relishes in punishing undisciplined traders

Source: Barchart

UNG closed on Thursday, February 1 at $24.35 per share and the ETF is not looking pretty at the current level, even though it is close to the lows. I am hopeful it will dip below the $20 level sooner, rather than later.

Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.