Natural Gas: The Shorts Get Caught

• A new low as open interest rises
• The shorts get over-enthusiastic- Hot weather ahead
• Levels to watch in the natural gas futures market

Natural gas has a long history as one of the most volatile commodities that trade on the futures markets in the United States. Since trading in natural gas began on the NYMEX division of the CME in 1990, the price has ranged from a low of $1.02 to a high of $15.65 per MMBtu. The low came in 1992, and the high in 2005.

The natural gas market has evolved over the past thirty years. Massive discoveries of the energy commodity in the Marcellus and Utica shale regions of the US increased the supply side of the fundamental equation for natural gas. Moreover, advances in hydraulic fracking to extract the gas from the crust of the earth and regulatory reforms under the Trump administration have made the US the world’s leading producer.

Since necessity is the mother of invention, replacing coal-fired power generation with natural gas and liquification of the gas for export to consumers worldwide have expanded the demand side of the equation. The price of natural gas reached a new twenty-five-year low in late June when nearby futures fell to $1.432 per MMBtu. As the number of speculative shorts grew, the price ran out of steam on the downside at 41.2 cents above the record bottom and recovered.

The United States Natural Gas Fund (UNG) reflects the price action in the NYMEX futures market. The UGAZ and DGAZ ETN products are short-term tools that magnify the price action by three-fold.

A new low as open interest rises

While the expiring July futures contract fell to $1.432 per MMBtu, the now active month August contract reached a bottom at $1.517 on June 25 and 26.

Source: CQG

The chart shows that the total number of open long and short positions in the natural gas market hit a low at 1.198 million contracts in early May when the price of August futures peaked at $2.447 per MMBtu. The open interest metric increased steadily as the price fell and stood at 1.317 million contracts on the days when the August futures contract hit its most recent low at $1.517. the price declined by around 38% from early May through late June as the open interest metric rose by over 9.9%. Rising open interest and falling price tend to be a technical validation of a bearish trend in a futures market.

The shorts get over-enthusiastic- Hot weather ahead

The rise in the open interest metric was likely caused by a rising number of speculative shorts looking for a new twenty-five-year low below the March bottom at $1.519 level. The natural gas market rewarded the nimble bears who sold the futures as the price dropped to a new low that was 8.7 cents below the March low. Those shorts that overstayed their welcome were punished. The price of August futures took off from the June 26 low at $1.517 and rallied to a high of $1.784 or 17.6% higher.

At the same time, the weather forecasts are for unseasonably warm temperatures over the coming days and weeks. The rising demand for air-conditioning could cause injections into storage to decline. Last week, the EIA reported a 65 billion cubic feet injection, which was lower than the market had expected.

The shorts got a bit over-enthusiastic in the natural gas arena, and it turned higher in what was an overdue price correction to the upside.

Levels to watch in the natural gas futures market

Over the coming days and weeks, we are likely to see a continuation of price volatility in the natural gas arena.  

Source: CQG

Natural gas should find significant technical support at the double-bottom at $1.517 per MMBtu. On the upside, the first level of resistance is at the June 5 high at $1.96. Above there, a double-top at $2.11 from May 18 and 19 could present formidable resistance before the price can challenge the early May peak at $2.447 on the August contract. The $2.11 level could be a reasonable target as the continuous contract high from early May stands at $2.162 per MMBtu. As of the end of last week, price momentum and relative strength indicators on the daily chart had risen from oversold conditions and were above neutral territory. Natural gas could have more room on the upside, given the technical position of the energy commodity at the end of last week.

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The United States Natural Gas Fund L.P. (UNG) was trading at $11.10 per share on Tuesday morning, up $0.39 (+3.64%). Year-to-date, UNG has declined -34.16%, versus a -0.81% rise in the benchmark S&P 500 index during the same period.

UNG currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #69 of 112 ETFs in the Commodity ETFs category.