Natural Gas: Sentiment To Remain Bearish As Hot Weather Will Not Last Long

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Includes: BOIL, DGAZ, KOLD, UGAZ, UNG
by: Andrei Evbuoma
Summary

Another bearish inventory report expected Thursday.

Strong natural gas output combined with cooler changes in the weather pattern provide strong catalyst for the bears and investors in UNG, DGAZ, and KOLD.

Downside risk to continue to outweigh upside potential.

Investment Thesis

Cooler changes via a major weather pattern shift in the medium range means that demand will not be able to keep pace with production. Expect downside risk to outweigh upside potential until heat begins to show up again.

Stronger confidence and consistency in forecast models on cooler changes coming in the medium range leads to sharp sell-off on Tuesday

The front-month August natural gas futures contract finished Tuesday down 3.80%, or 10.2 cents ($0.102), to $2.306. The September contract also settled lower 10 cents ($0.100) to $2.286.

Figure 1 below is a chart depicting the price trend of the front-month August contract over the past 5 trading sessions.

Source: Investing.com

On Tuesday, the United States Natural Gas ETF (UNG), which is the unleveraged 1x ETF that tracks the price of natural gas, finished down 3.53% to $19.94.

UNG's leveraged exposure ETFs, the VelocityShares 3x Long Natural Gas ETN (UGAZ) and the ProShares Ultra Bloomberg Natural Gas ETF (BOIL), finished lower Tuesday 10.60% and 6.79% at $16.07 and $13.99, respectively. Meanwhile, UNG's high-beta leveraged inverse ETFs, the VelocityShares 3x Inverse Natural Gas ETN (DGAZ) and the ProShares UltraShort Bloomberg Natural Gas ETF (KOLD), finished higher Tuesday 9.96% and 6.72% at $152.84 and $29.66, respectively.

Multi-day heat wave over the central and eastern U.S. through next weekend will give way to a major pattern shift to more seasonable temps across the central and eastern U.S., and a hot west U.S. in the 6-16 day time frame

The story over the next 5 days will be the high heat and humidity. An elongated mid/upper level ridge extending from the Southwest U.S. to the western Atlantic will strengthen and thus yield widespread 90s with heat indices ranging from 100-110F+ across the central and eastern U.S. mid-week through the upcoming weekend.

Figure 2 below is a map from the 18z GFS ensemble (GEFS) depicting the 0-5 day (July 16-21) temperature pattern.

Source: WeatherBell

Once past next weekend, the weather pattern looks to undergo a major shift (in the 6-16 day range) as forecast models have indicated and remained consistent on. This shift will include the heat relaxing over the central and eastern U.S. (downstream troughing) as the heat dome/upper level ridging shifts westward or further upstream taking aim over the West U.S. During this time frame, the national pattern will have to look of a hot West U.S. vs. a cooler/mild central and eastern U.S.

Figure 3 below is a map from the 18z GFS ensemble (GEFS) depicting the 6-11 day (July 22-27) upper level/jet stream pattern.

Source: WeatherBell

Figure 4 below is a map from the 18z GFS ensemble (GEFS) depicting the 6-11 day (July 22-27) temperature pattern.

Source: WeatherBell

Figure 5 below is a map from the 18z GFS ensemble (GEFS) depicting the 11-16 day (July 27-August 1) upper level/jet stream pattern.

Source: WeatherBell

Figure 6 below is a map from the 18z GFS ensemble (GEFS) depicting the 11-16 day (July 27-August 1) temperature pattern.

Source: WeatherBell

Final Trading Thoughts

Over the course of two trading sessions, the prompt-month August contract has pulled back over 14.5 cents. Despite the impending heat wave this week through the upcoming weekend, the outlook of cooler changes to the central and eastern U.S. in the medium range (6-16 day time frame) dictated the market's reaction. Given the amount of heat and strong cooling demand that's to come this week, it just goes to show how bearish the market is overall. Natural gas production has been and continues to be robust. This is backed by mostly bearish inventory reports issued over the past several weeks. Cooler changes on the way across the central and eastern U.S. in the medium range dampens natural gas bulls' hopes for a sustained rally and places the market firmly in the hands of the bears. Until we see a meaningful drop in production and/or heat shows back up in the forecast models, downside risk will continue to outweigh upside potential.

My price range will be $2.10-2.40 over the next week for the front-month August futures contract, with UNG trading between $17.00 and $21.00.

Stay Tuned For More Updates!

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.