Near-Term Buy Signals for Natural Gas and Electricity

The purpose of this Energy Alert is twofold:

1. Notify our clients of a near-term buy signal for Natural Gas and Electricity, which are highly correlated to each other.
2. Evidence for higher prices longer-term from a technical and seasonal perspective.

1) Near-term buying signal for Natural Gas and Electricity

Over years of trading commodities I have 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 move is likely to the upside. To appreciate why this happens you need to understand how large hedges are built during a bull market.

The characteristic of a long-term bull market is that it forms a pattern of higher highs and higher lows. The reason for this is large hedgers build their positions in stages. They do not chase the market; they patiently wait for pullbacks and enter their positions on bearish news. The only way to build a large buy position is to have a large number of sellers willing to take the other side of the trade. A bearish report offers large hedgers the ideal opportunity to build their positions. In the chart below you can see 3 recent buying signals, which were all triggered after bearish Natural Gas Storage Reports.

Natural Gas Chart Oct 25, 2013
The Storage Reports on Aug 8th, Sep 26th and Oct 24th all announced larger than expected increases in Natural Gas storage, which fundamentally should have caused prices to decline, but in each case after sharply declining after the announcements within a few seconds the market reversed and spiked higher. The only explanation for this trade action is there were large buy orders placed electronically below the market waiting for an opportunity to be filled. Once those orders are filled the market was ready to move higher and the buy signals on Aug 8th and September 26th were followed by rallies the following week. Yesterday’s buy signal will likely lead to higher prices next week; therefore, if you are considering a hedge at this time we recommend you execute as soon as possible.

2) Evidence for higher prices longer-term from a technical and seasonal perspective.
What is the evidence for higher prices longer-term for Natural Gas and Electricity? First, we will address the evidence from a technical perspective by looking at the chart below.

Natural Gas Chart Oct 25, 2013
In the above chart I point out two periods in which the Commitment of Traders Report (COT) indicated Commercial Hedgers were building buy positions. The first period occurred last winter. Commercial Hedgers from early December 2012 thru the middle of February 2013 were building buy positions while traders were building sell positions. A colder than normal period from the middle of February thru early April triggered the next leg higher, but this was only an excuse for pricing to move in the direction Commercial Hedgers were preparing for. Over the years, I have found it is wise to follow the lead of Commercial Hedgers. They are more highly capitalized than traders and have a vested interest to move the market based on their capitalization.

As you can see in the above chart, since early in June Commercial Hedgers are again building their buy positions, and since Aug 8th we have experienced three separate buy signals triggered by sharp reversals after bearish Natural Gas Storage Reports. No one knows how much longer Commercial Hedgers will build their buy positions prior to the next leg higher and what will trigger the move higher, but certainly it is in the vested interest of Commercial Hedgers for prices to move higher at some point in time.

Next we will consider the evidence for higher prices from a seasonal perspective. We are presently in the middle of the fall shoulder period for energy. During the fall shoulder period prices tend to decline between the summer cooling and winter heating seasons. But this year since reaching a low in the middle of the summer on August 8th, Natural Gas and Electricity have slowly increased, ignoring bearish fundamentals of higher than expected Natural Gas storage builds due to mild weather and a storm season that was a non-event. Remember, when a market moves higher with bearish news it is signaling the next major move will be up.

There is one last factor to consider. Historically the low reached during the fall shoulder is lower than the low reached in the spring shoulder, which occurs between winter heating and summer cooling periods. There certainly are exceptions such as in 2011/12, when we experienced the warmest winter in 100 years, or 2008/09, when we experienced a financial meltdown. But in more than two out of three instances, without extenuating circumstances, the evidence points to higher prices in the spring; therefore, we recommend clients with hedges expiring within the next year consider extending those hedges at this time.

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. We invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Energy Analyst