Natural gas: An oasis for fundamental traders

In an environment of unprecedented accommodation from the Federal Reserve, even a hint that the money printing will be curtailed can act like a tsunami on financial markets, sparking massive selloffs in equities, fixed income, currency and commodity markets. With the constant risk of shifting Fed policies, the past few years have been exceptionally difficult for traders, with even the most well-developed and fundamentally sound trends swept away with the tide of easy money and subsequent sterilization. Despite the central bank headwinds, there are still several markets where traders can find refuge from this policy risk, an oasis where commodity-specific fundamentals prevail.

Chart 1 shows a matrix of the most highly correlated commodities, markets where regardless of the underlying fundamentals, the wrong word from Fed Chairman Ben Bernanke can overwhelm the most well-conceived thesis. Not surprisingly, commodities that are highly sensitive to economic conditions are most at risk of being affected by external factors. Specifically, the energy complex (crude oil and distillates), base metals (copper, nickel, et al), and precious metals (gold and silver) are particularly sensitive to general financial market conditions.

Chart 2 shows the commodity markets that are least correlated to financial markets, and therefore provide a degree of protection against contagion stemming from central bank or government actions designed to stoke or cool the economy. These tend to be agricultural commodities, driven primarily by weather, crop conditions, and demand for food. The star safe haven from financial market volatility however, is natural gas.

Over the past year, natural gas prices have demonstrated absolutely no sensitivity to equity prices, unlike most commodities, and on days when virtually every market is swept up in central bank headline news, natural gas is reliably unaffected.

The fuel’s independence can be attributed to a couple key factors. US benchmark Henry Hub natural gas, the variety traded on the NYMEX, is effectively trapped in the domestic market, and therefore it is largely immune to forces beyond the borders, unlike crude oil which is a globally-traded commodity. It is also difficult to store, and therefore a bad candidate for commodity traders to stockpile, unlike metals like gold and copper – this means that fundamentals tend to prevail.

While it remains one of the most volatile commodity markets, natural gas is a prime candidate for traders disillusioned with the current market, and its tendency to move in tandem.

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