Perfect Scenario Nearing Completion

In my last Energy Alert on June 24^th I said a close below $4.40 in Natural Gas could trigger a quick decline towards $4.00 in an attempt to fill a gap left behind when the market began its surge higher in early January 2014. The 12-month chart below shows where Natural Gas was trading on June 24^th.

In my June 24^th Energy Alert I said reaching this possible price objective would be the perfect scenario for entering new hedges. Below is a chart of where Natural Gas is trading this morning.

As you can see in the above chart as I predicted if Natural Gas closed below $4.40 it would trigger a quick decline towards $4.00 in an attempt to fill the gap.

This is classic trade action, which is often repeated for the following reasons:

1)    When a market leaves a gap behind during a market rally it creates an area of lost opportunity for traders who want to build positions at lower levels.

2)    In essence it can become a self-fulfilling prophecy as technical traders patiently wait for this price objective.

3)    Many traders realizing this tendency place orders near this price objective thereby becoming a self-fulfilling prophecy as the market reaches this area and then rallies.

There is no guarantee this area will hold long-term, but in the short-term once the gap is filled in most instances a rally attempt will follow. The most important question is whether Natural Gas near $4.00 a good value for hedges? I believe it is. In my May 29^th Energy Alert I said if we experience a mild summer Natural Gas could decline moderately to test the lows reached prior to the winter rally near $3.70 and electricity rates would marginally decline. Thus far we have experienced a mild start to summer and as predicted in my June 24^th Energy Alert we are nearing the idea scenario to fill a gap left behind when extremely cold weather arrived in early January 2014. The gap near $4.00 is within 30 cents of where Natural Gas was trading in early November 2013 before the winter rally began.

I believe large hedges being risk averse will use this as an opportunity to enter hedges at this time. Their downside reward potential for waiting is minimal, and there is no guarantee it will remain cool for the remainder of the summer. Remember with storage levels of Natural Gas still 27.6% below the five year moving average the risk of higher prices in the second half of 2014 is great.

As I have stated many times hedgers should not try to catch the exact bottom, which 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 hedgers don’t have that luxury, since if they miss the bottom they are inherently short the market. As discussed in my May 29^th Energy Alert the risk/reward ratio at that timewas approximately 3 to 1 against delaying reserving hedges, butbased on the latest inventory levels and today’s price levels the risk/reward ratio is now much greater than 3 to 1.

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 Energy Analyst