Now that the NYMEX natural gas futures market has rolled to the active month December futures contract, the winter season in the energy commodity is in full swing. December futures hit a low at $2.84 per MMBtu on September 14 and the approaching peak season of demand lifted the price to a high of $3.409 on October 10. After a dip to $3.133 on October 29, the price was back above the $3.25 level on November 2.
December natural gas futures broke above their level of technical resistance which stood at the June 18 high at $3.163 on September 27. After a brief dip below that level at the end of October, the price is now back above as inventories will begin to decline as temperatures turn colder and demand for heating will rise in the United States over the coming weeks and months.
The next level of technical resistance on the longer-term chart stands at the February 2018 peak at $3.661 per MMBtu. While Mother Nature will determine if natural gas becomes a roaring bull or a tame bear over the 2018/2019 winter season, stockpiles of the energy commodity are telling us that we could be in for lots of price volatility during the peak season.
As we are on the cusp of the time of the year when stockpiles of natural gas begin to fall in the United States, price variance in the futures market is bound to increase with the weather forecasts and weekly stockpile data from the Energy Information Administration. For those who do not venture into the highly-leveraged and volatile waters of the futures arena, the Velocity Shares 3X Long Natural Gas ETN product (UGAZ) and its complimentary product the Velocity Shares 3X Short Natural Gas ETN product (DGAZ) offer market participants an alternative to futures. These products can turbocharge returns for those with their fingers on the pulse of the natural gas futures market that trades on the NYMEX division of the CME over the coming weeks and months. Meanwhile, as we head into the withdrawal season for the natural gas market this month, price volatility is already picking up, and the price continues to trend towards the recent highs in the energy commodity.
The price action is strong
On a technical basis, the price action in the NYMEX natural gas futures market is strong on the daily, weekly, and monthly charts.
The daily chart highlights that price momentum on the December futures contract has crossed higher in neutral territory over recent sessions. Relative strength is neutral, and daily historical volatility has declined to under 28% from a high of over 35% at the beginning of October when the price of the energy commodity was on its way to the high at over the $3.40 per MMBtu level. The one concerning sign is that open interest, the total number of open long and short positions in the futures market, declined from just under 1.7 million contracts in early October to its current level at 1.52 million on November 1. Rising price and falling open interest is typically not a technical validation of an emerging bullish trend in a futures market.
The weekly chart illustrated that price momentum, and relative strength continues to rise, albeit into overbought territory.
Meanwhile, the monthly chart displays that price momentum crossed higher and is rising in neutral territory. All three charts in the natural gas futures market indicate a bullish trend as we enter the season of peak demand in November.
Injections remain weak
On Thursday, November 1, the EIA reported that natural gas inventories across the United States rose by 48 billion cubic feet for the week ending on October 26. The injection was slightly below my expectations of a rise of 50 bcf for the period.
As the chart shows, total inventories stood at 3.143 trillion cubic feet as of the final week of October which was 16.5% below last year's level and 16.9% under the five-year average for this time of the year.
Despite record production of natural gas from the Marcellus and Utica shale regions of the United States because of technological advances in hydraulic fracking, natural gas has dribbled into storage throughout the 2018 injection season. It is likely that increased demand from electricity generation and shipments of LNG increased demand for the energy commodity preventing stockpiles to build to levels seen in past years.
The lowest level of stocks in years
Now that it is November, stocks of natural gas will begin to decline as the demand for heating rises over the coming weeks. With only one to two weeks left in the 2018 injection season, it is unlikely that stocks will rise much above the 3.25 tcf level when drawdowns commence. To reach that level we will need to see an average injection of 53.6-107.1 bcf over the coming two weeks, but additions to storage tend to tail off at the end of the time of the year when additions turn to withdrawals.
Last year we went into the withdrawal season with 3.79 tcf in storage, and this year the stocks will be more than 500 bcf lower. As we approach the 2018/2019 winter season, stockpiles are at the lowest level in many years.
If Mother Nature makes it a cold winter watch out
In 2014, the price of the energy commodity rose to a high of $6.493 per MMBtu when inventories fell to a low of 824 bcf at the end of the winter withdrawal season. In late 2013, stockpiles were at 3.779 tcf during this week before the cold winter season. This year, we are 636 bcf below that level. Therefore, a cold winter could drain storage and cause the price of the energy commodity to move significantly higher over the coming weeks and months.
The weather forecasts for the first weeks of November have been for warmer than average temperatures. However, only Mother Nature knows how cold it will get during December, January, February, and March. A cold start to winter during the holiday season could send shivers through the natural gas market and cause a rush of speculators into the market on the long side. A white and frozen Christmas and New Year's Eve in 2018 could lead to lots of financial gains for those who have stuffed their stockings with long positions in the natural gas futures market and related derivatives.
UGAZ and DGAZ to trade a market that may be more volatile than usual this year
In September, when the price of natural gas was languishing at below the $2.80 level, and historical volatility was low, I loaded up on call options in NYMEX natural gas futures with expiration dates for January, February, and March of 2019. During the recent rally in October, I took profits on half of the position which more than covered the premium I spent on the options. I am now sitting with call options with strike prices ranging from $3.20 to $3.40 per MMBtu without any financial risk and lots of potential upside rewards.
Over the coming weeks and months, I will be trading futures and the Velocity Shares 3X Long Natural Gas ETN product (UGAZ) and its complimentary product the Velocity Shares 3X Short Natural Gas ETN product (DGAZ) to take advantage of price variance in the natural gas market. These triple-leveraged products are only appropriate for short-term forays into the natural gas market as they suffer from extreme price decay for those who overstay their welcome in positions on the long or short sides of the natural gas market. The fund summary for UGAZ states:
The investment seeks to replicate, net of expenses, three times the performance of the S&P GSCI Natural Gas Index. The index comprises futures contracts on a single commodity and is calculated according to the methodology of the S&P GSCI Index.
UGAZ uses futures and options to achieve its gearing on the long side of the market, and DGAZ does the same on the short side. Both of these products can offer spectacular rewards for nimble traders with their fingers on the pulse of the natural gas market, but the risk of staying in a position too long can cause significant losses.
On September 10, December natural gas futures traded to a low of $2.855 and by October 10 they rose to a high of $3.409 per MMBtu, an increase of 19.4% over the period. At the same time, UGAZ moved from $54.60 to a high of $96.89, or 77.5%, more than triple the appreciation of the now active month December futures contract.
On November 1, December futures settled at $3.237 per MMBtu, 5% off its October 10 high while UGAZ closed at $83.48 per share, 13.8% off its high, just less than three times the loss. At the same time, DGAZ moved from $13.10 per share on October 10 to close at $14.58 on November 1, a rise of 11.3%, under a triple return compared to the price action in the natural gas futures market on the short side.
UGAZ and DGAZ are excellent products for short-term trades in the natural gas market but remember to take those profits when they are on the table and get out of positions when they begin to turn south, or the ETNs could become dust collectors in your portfolio when they reverse split 1-10 as UGAZ did not too long ago.
Natural gas is hanging in there near the recent highs as the 2018/2019 withdrawal season will commence in just a couple of weeks. Mother Nature will have the final say for the path of least resistance of the price of the energy commodity over the coming months. However, the low level of inventories could mean that we are in for a volatile period in the natural gas market with lots of opportunities for the long and short sides of the market during the period of peak demand.
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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.