How to Play the End of the Natural Gas Rally
The US Energy Information Administration (EIA) weekly natural gas inventory report showed gas in storage fell more than analysts were expecting. In fact, for the week of January 4, 2013, inventories fell 201 billion cubic feet (bcf). That’s above analysts’ estimates for a 185 bcf storage draw.
Thanks to a recent spate of cold weather in key US heating regions, natural gas demand surged in the first week of 2013. As a result, inventories shrunk and the price of natural gas rose 2.5% to $3.19 mmBtu.
Yes, in the short-term, it is good news. Bulls may get a chance to ride natural gas back up to $3.50 in coming weeks.
However, unless temperatures stay shockingly cold over the next two months, the price of natural gas is destined to dwindle.
Let me explain why…
Long-time readers know I’ve been bullish on natural gas since the middle of 2012 when the price was hanging around $2.00. My bullish thesis revolved around a dramatic slowdown in dry gas drilling, increasing demand from utilities, and a cold 2012/13 winter.
As you may know, the bullish thesis played out nicely in the second half of 2012 as natural gas rose to $3.90… nearly a 100% jump from earlier in the year.
But in the past few weeks, it’s been all downhill…
Even though yesterday’s EIA data was bullish, data over the past month has been decidedly bearish. As a matter of fact, up until yesterday, natural gas in storage was still holding above last year’s levels by 2% and above the 5-year average by 12%.
How can that be?
First of all, late November and early December were just too darn warm in many parts of the US. As a result, gas inventories actually rose in mid-December due to the lack of heating demand. Usually we see a drawdown that time of year.
Those warm temperatures got the 2012/13 heating season off on the wrong foot for natural gas bulls.
And now that the winter heating season is already half over, we’ll need extremely cold weather and a huge drop-off in inventories for natural gas prices to keep a bullish tone.
Yesterday’s report was a good start, but we’ll need much more than that to keep the price above $3.00 in coming months.
And warm temperatures aren’t the only bearish factor…
Marcellus shale gas production is still growing even though dry gas rig counts are in the gutter nationally. As you may know, the Marcellus is an abundant natural gas resource in the Northeastern US.
According to the EIA’s Short Term Energy Outlook, recently drilled wells in Pennsylvania and West Virginia are still coming online. As a result, we’re not seeing the big natural gas production drop-off expected a few months ago.
So am I giving up on my bullish natural gas outlook?
In the near-term, my views are now neutral. The next few weeks of natural gas trading completely depend on the weather.
However, I’m still betting natural gas will rise above $4.00 in 2013. Once US production finally rolls over due to the drilling slowdown, natural gas bulls will have their day.
But as you may have guessed, it’s more likely we see that rise at the end of 2013 as opposed to the beginning. In other words, the odds of natural gas rising above $4.00 in the next two months are decreasing rapidly.
So if you’re still long natural gas (via an ETF or otherwise), it’s best to sell into any upcoming rallies…
If you’re an aggressive trader, you may be interested in shorting the natural gas market. You can do it via the ProShares UltraShort DJ-UBS Natural Gas (KOLD) or the Velocity Shares 3X Inverse Natural Gas ETN (DGAZ).
However, extreme caution is warranted with those two ETFs.
Both KOLD and DGAZ are leveraged. In other words, a 2% daily rise in the price of natural gas will result in a 4% drop for KOLD and a 6% drop for DGAZ.
Until Next Time,
–Justin BennettSource: Dynamic Wealth Report
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