- The market is in oversold territory
- Historical volatility is close to the bottom
- Open interest points to an imbalance in market positions
My background as a physical commodities trader makes me particularly sensitive to fundamental supply and demand data. I have been trading a wide range of raw materials over the past four decades. I have found that an understanding of changes in production levels, inventories, output costs, consumption levels, and the elasticity of supply and demand are variables that often drive commodities prices higher or lower over time. The lion’s share of my most successful long and short positions occurred when the price of a commodity moved to the bottom or the top end of its pricing cycle.
Meanwhile, I never ignore the overall sentiment of a market. When I first got started in the business, one of my first bosses told me that market prices move higher when there are more buyers than sellers, and lower when the converse occurs. Charts and technical indicators are price maps, and history tends to repeat.
The recent price action in the natural gas futures market has been highly bearish, and supply and demand data continue to point lower. However, the long-term chart is telling us that the risk of a short position is rising with each new low in the volatile energy commodity. The United States Natural Gas Fund (UNG) tracks the nearby price action in the NYMEX futures market.
The market is in oversold territory
On Friday, February 7, the price of nearby March natural gas futures settled at $1.858 per MMBtu. The high for last week was at $1.906, and it seems like any attempt at a recovery has been another selling opportunity for market participants. The long-term technical picture for natural gas futures, which began trading in 1990, remains bearish. However, technical indicators have declined into an abyss as they are at a historically low level.
Source: CQG
As the quarterly chart highlights, the slow stochastic, a price momentum indicator has declined to an even lower level than the first quarter of 2016 when nearby futures traded to a low of $1.611 per MMBtu. Quarterly relative strength at 29.25 is at its lowest level in three decades since futures on NYMEX began trading.
Historical volatility is close to the bottom
Natural gas is a combustible commodity in its natural form, but the price can be equally volatile as explosion and implosions have occurred since 1990. The range in quarterly historical volatility has been from just over 12% to over 80%.
Source: CQG
The chart shows that the measure of price variance at 14.15% at the end of last week was just above the three-decade low.
Open interest points to an imbalance in market positions
Open interest is the total number of open long and short positions in a futures market. When then metric moves higher during a bullish or bearish trend, it tends to validate the move from a technical perspective.
Source: CQG
The weekly chart shows that open interest rose from a low of 1.16 million contracts in early November when the price of nearby futures rose to a high of $2.905 per MMBtu. At under $1.90 at the end of last week, the metric stood at 1.54 million contracts. Open interest rose 380,000 contracts or 32.8% as the price fell to lower lows since the beginning of the winter season. While the increase in the total number of open long and short positions validates the bearish price action, it also means that there is likely an overabundance of trend-following technical shorts in the natural gas market. In a volatile commodity like natural gas, few things ignite a rally like an imbalance on the short or long side of the market.
The trend is always your friend in markets. In natural gas, the path of least resistance remains lower. However, technical metrics are telling us that the risk of a short position is rising with each new low.
The United States Natural Gas Fund L.P. (UNG) was trading at $13.80 per share on Monday afternoon, down $0.65 (-4.50%). Year-to-date, UNG has declined -40.82%, versus a 25.32% rise in the benchmark S&P 500 index during the same period.
UNG currently has an ETF Daily News SMART Grade of C (Neutral), and is ranked #51 of 109 ETFs in the Commodity ETFs category.
About the Author: Andrew Hecht
Andrew Hecht is a sought-after commodity and futures trader, an options expert and analyst. He is a top ranked author on Seeking Alpha in various categories. Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup. Over the past decades, he has researched, structured and executed some of the largest trades ever made, involving massive quantities of precious metals and bulk commodities. Aside from contributing to a variety of sites, Andy is the Editor-in-Chief at Option Hotline.