Bullish Reaction to Bearish News

In my April 1^st spring update, I reemphasized from a historical perspective Natural Gas and Electricity rates are highly correlated to each other and both were at very low price levels, and I believed they were setting up for a short covering rally. But I also said due to the mild conclusion of the winter heating season we were retesting the Feb 6th low on April 1^st.

Below is the one year chart of Natural Gas prices, which was included in my April 1^st report.

At that time I asked the rhetorical question is it possible in the near-term Natural Gas could break below the Feb 6^th low?

My answer was it was certainly possible, but because Natural Gas prices have been lower than present levels less than 5% of the time over the last 13 years, the time spent below present price levels would likely be short lived, and any break in prices would likely be followed by a short covering rally based on the large open interest of large commercial hedgers, which I discussed in my March 4th report.

 The one year chart below shows Natural Gas’s pricing as of May 5^th.

As you can see in the above chart, after my April 1^st report Natural Gas prices broke below the Feb 6^th low for a short period of time starting on April 9^th prior to rallying above the Feb 6^th low on April 29th as shown in red. The decline was triggered by a combination of milder than normal weather and larger than expected builds of Natural Gas supplies as reported by the EIA in their weekly storage report.

The injection period of Natural Gas runs from April 1^st through the end of October. During this period supplies of Natural Gas are built ahead of the high demand during the winter heating season. This year the build got off to a robust start largely due to the very mild weather we experienced in April. Natural Gas supplies increased by 249 BCF during April 2015 while in April 2014 supplies only increased by 159 BCF.

Over years of trading commodities I learned the way a market reacts to news is more important than the news itself. If a market does not decline with bearish news it is signaling the next major move is likely to the upside. Until last week, the EIA reports were very bearish with larger than normal builds since the start of the injection period. The report last week was mildly bullish with a build of 81 BCF slightly lower than last year’s build of 82 BCF, and the market rallied sharply higher as you can see in the above chart, and we are now higher than where we were on April 1^st.

The news in April overall was bearish for Natural Gas, but prices were higher for the month. Clearly we have experienced a bullish reaction to bearish news and the path of least resistance appears to be to the upside.

Short term weather patterns remain mild; therefore, the present rally may stall near-term, but I believe the downside risk is minimal. But if temperatures rebound in May, I believe inventory builds in 2015 will quickly fall below 2014, and Natural Gas will rally from present levels. Although it is possible rates could go slightly lower in the short-term, I don’t recommend trying to catch the exact bottom at this time.

As I have stated in previous reports this is the role of a speculator. If a speculator misses the exact bottom it does not cost them anything except opportunity cost, and opportunity cost is not as expensive as lost capital. But as a hedger you don’t have that luxury, since if you miss the bottom you are inherently short the market. Remember, we have been lower than present levels less than 5% of the time over the last 13 years, and I believe the market is looking for any excuse to move higher.

Not every client’s risk tolerance and hedging strategy is the same, but we trust the above report will help you put into perspective the risk/reward opportunities at this time. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Commodity Analyst