After failing for the third time in 2014 to break through the $4.90 level in mid-June, natural gas prices(NYMEX:NGQ4) have depreciated nearly 20%. In fact, for the first time since mid-January, front month natural gas prices are currently trading below the key psychological level of $4. A closer look at a daily chart shows that a gap was filled this week, which indicates we may be close to an inflection point. While past performance is not indicative of future results the last time we traded around current levels, buyers showed up and within six weeks, prices screamed higher by some 25%. Keep in mind, however, that the fundamentals are far different this time around as we continue to see below-normal temperatures contributing to above-average injections in our weekly storage numbers (see below).
Constituting perhaps the main driver behind the natural gas price action we are seeing currently, the recent significant build-up in supplies should not go unnoticed. The current trend of thirteen weekly injections above the 5-year average has kept the bears firmly in the driver’s seat. The polar-vortex-like conditions that drained supplies this past winter seem to have the opposite effect of late with cooler summer temperatures tempering air conditioning-driven demand for natural gas. If and when temperatures rise in the United States over the coming weeks, a development that’s in the cards if weather projections are to be believed, I would expect natural gas to find its footing. Under normal circumstances, natural gas stockpiles tend to rise in the spring after heating demand fades and warmer weather kicks, with stockpile additions usually slowing down by mid-July. This has not been the case this year: we have seen uncharacteristically high and prolonged injections, something that’s almost a little awe-inspiring given that storage levels were near eleven-year lows this past winter. While this is an important point to note in terms of explaining natural gas price action up until now, I do not expect for this trend to continue unabated especially if we see warmer weather in the near future.
A look at a weekly chart reveals that we are, at present, approaching the trend line that has acted as support for the past two years. The next couple of sessions will show if this level can hold or if we’ll see a trade lower to the 61.8% Fibonacci level that on a front month continuation chart comes in 30¢ lower. For aggressive traders, I have lightly started to tip toe into bullish trades. One way of going about this would be to gain long exposure in November natural gas futures while, at the same time, selling out-of-the-money calls 1:1. Traders who’d wish to add protection against further immediate downside risk could also purchase out-of-the-money puts until an interim low is established in the August or September contracts. In previous sessions, I’ve had a few clients in August puts but we have now let go of those trades at a profit on this week’s decline. As matters stand right now, on the trade overall, I have clients with realized profits in the August puts, unrealized losses in the November futures as well as unrealized profits in the November calls.
While futures prices may have already factored in the seasonal aspects of supply and demand, it is worthwhile to keep in mind that in the past, we have typically seen a trade higher into the fall. Whether we actually bottom in the coming weeks and start trending higher as has been the case for the past 15 years remains to be seen. Past performance is certainly not indicative of future results but should 2014 follow a similar pattern to past years, look out for a low around the $4 mark with an ensuing trade higher into the fall. There may be room for a price appreciation of 40 to 60¢ higher.