The most recent low in the natural gas futures market came on January 17, when the price fell to $1.994 per MMBtu. In August 2019, the price of the energy commodity declined to a low of $2.029, which stood as the previous level of critical technical support.
The price of the nearby February futures contract rose to a peak of $2.926 in early November, while the high at the same time on the continuous futures contract was at $2.905. The high at the start of the 2019/2020 withdrawal season and peak season of demand was a far cry from the prior year when it rose to $4.929 per MMBtu. Meanwhile, in late 2019, the level of inventories in storage around the US did not support a higher price for natural gas like it did in late 2018. With only ten weeks to go in the 2019/2020 withdrawal season when stockpiles decline, the tone of the natural gas market is bearish. A test of lower levels appears to be in the cards for the energy commodity as the February futures are rolling to March, the month that ushers in the spring season and time of the year when stockpiles begin to rise.
The Velocity Shares 3X Inverse Natural Gas ETN product (DGAZ) magnifies the price action in the natural gas futures market on the downside.
The weather has been warm
So far, the winter season has seen temperatures above-average levels across the United States. Temperatures in New York City and Boston later this week will be in the mid-to-high forties. Chicago will see mid-day readings in the high 30s. The demand for heating is peaking at this time of the year, but there are no strains on natural gas supplies, which accounts for the price weakness.
Source: CQG
The weekly chart highlights that nearby February NYMEX natural gas futures put in a bearish reversal last week. The price traded to a marginally higher high than the previous week of $2.255 and then proceeded to probe below the $2 level and settle at $2.003, below the prior week’s low. While price momentum and relative strength indicators have declined into oversold territory, both metrics continue to trend lower. Weekly historical volatility at just under 37% reflects the recent move to the downside that took the price to the lowest level since 2016.
Meanwhile, the total number of open long and short positions rose to 1.507 million contracts at the end of last week. Increasing open interest and falling price tends to be a technical validation of a bearish price trend in a futures market.
Another small inventory withdrawal for this time of the year
Last Thursday, the Energy Information Administration told the natural gas market that stockpiles fell by 109 billion cubic feet for the week ending on January 10.
Source: EIA
Stocks of 3.039 trillion cubic feet were 19.4% above last year’s level and 5.4% above the five-year average for this time of the year. The high level of stocks has encouraged speculative shorts to push the price of the energy commodity lower. We could see lower prices in the coming weeks and months as both technical and fundamental factors are creating a potent bearish cocktail for the natural gas futures market.
Stocks will go into the injection season way above last year’s level
In March 2019, natural gas stockpiles reached a low of 1.107 trillion cubic feet. With around ten weeks to go until the beginning of the 2020 injection season when stocks build, an average drawdown of 193.2 billion cubic feet would be necessary for inventories to fall to last year’s low. Considering that the largest injection so far this season was only 161 bcf, the odds of a lower level going into the injection season are almost nil. Half of the winter season is over, and it will not be long before the coldest time of the year becomes a memory. Even if cold grips the US over the coming weeks, the low levels of withdrawals since November will keep inventories at high levels going into the injection season.
An oversold market could experience a rally
The potential for a price recovery tends to rise in markets that decline into oversold territory.
Source: CQG
The monthly chart shows that price momentum and relative strength both display oversold readings. Monthly historical volatility at just over 24% is a lot closer to lows than highs.
Meanwhile, any attempts at a rally have attracted selling to the natural gas arena since November 2019. The target on the downside for speculative bears is now at the March 2016 low of $1.611 after the move below $2 on January 17. The 2016 bottom was the lowest price for the energy commodity since the late 1990s and stopped just one tick or $0.001 above the 1998 low of $1.61. Therefore, any uptick in the price could be another selling opportunity until the price reaches a bottom, which could come in the spring at the end of the winter of 2019/2020.
DGAZ on a recovery
The rise in open interest is at least partially because of shorts wagering on new and lower lows over the coming weeks. The most direct route for a short position in the natural gas market is via the futures and futures options offered by the NYMEX division of the CME. For those market participants who do not venture into the futures arena, the Velocity Shares 3X Inverse Natural Gas ETN product (DGAZ) provides a leveraged alternative. The fund summary for DGAZ states:
“The investment seeks to replicate, net of expenses, three times the opposite (inverse) of this GSCI Natural Gas Index ER. The index comprises futures contracts on a single commodity and is calculated according to the methodology of the S&P GSCI Index.”
Source: Yahoo Finance
DGAZ has net assets of $155.43 million, trades an average of over 1.23 million shares each day, and charges a 1.65% expense ratio. Last week, the price of natural gas fell from $2.255 on January 14 to a low of $1.994 on January 17, a move to the downside of 11.57%.
Source: Barchart
The chart illustrates that over the same period, DGAZ jumped from $169.41 to $231.33 per share or 36.55%, a little over triple the percentage move to the downside in the February NYMEX natural gas futures contract.
Triple leveraged products like DGAZ are not for the faint of heart. If the price stabilizes or moves higher, the value of the ETN will evaporate quickly. For those looking for a correction to the upside because of the current oversold condition, the bullish UGAZ product offers the same exposure and leverage on the upside in the natural gas market.
With half the winter season over and stocks at an elevated level compared to last year and the five-year average, the selling pressure in the natural gas futures arena is likely to continue over the coming weeks. Sellers are likely to be looking for any correction to the upside to add to risk positions as they have their sights set on the March 2016 low.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.
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