Best of the Week
Most Popular
1. Will Gold Price Breakout? 3 Things to Watch… - Jordan_Roy_Byrne
2.China Invades Saudi Oil Realm: PetroDollar Kill - Jim_Willie_CB
3.Bitcoin Price Trend Forecast, Paypal FUD Fake Cryptocurrency Warning - Nadeem_Walayat
4.The Stock Market Trend is Your Friend ’til the Very End - Rambus_Chartology
5.This Isn’t Your Grandfather’s (1960s) Inflation Scare - F_F_Wiley
6.GDX Gold Mining Stocks Fundamentals - Zeal_LLC
7.US Housing Real Estate Market and Banking Pressures Are Building - Chris_Vermeulen
8.Return of Stock Market Volatility Amidst Political Chaos and Uncertain Economy - Buildadv
9.Can Bitcoin Price Rally Continue After Paypal Fake FUD Attack? - Nadeem_Walayat
10.Warning Economic Implosion on the Horizon - Chris_Vermeulen
Last 7 days
Is a Stock Market Crash Imminent or Does this Stock Market Bull Still Have Legs - 25th Apr 18
Gold Price Focusing on May Cycle Bottom - 25th Apr 18
Cash “Vanishes” From Bank Accounts In Ireland - 25th Apr 18
Is the Malaysian Economy a Potemkin Village - 25th Apr 18
Land Rover Discovery Sport Rattling / Knocking Sounds From Car Pillars - 25th Apr 18
China Takes the Long View on Gold-Silver... and So Should You - 25th Apr 18
Russia Buys 300,000 Ounces Of Gold In March – Nears 2,000 Tons In Gold Reserves - 24th Apr 18
Stock Market Study Shows Why You Shouldn’t “Sell in May and Go Away” - 24th Apr 18
CRYPTOCURRENCY MASTERCLASS #CRY90 - 24th Apr 18
UK Gambling Statistics - What the Numbers Say - 24th Apr 18
Chaos Capitalists Short Countries - How Chanos Got China Wrong - 24th Apr
Artificial Intelligence Defines the Political News Narrative - 24th Apr 18
Stock Market "Oops, They Did It Again" - 24th Apr 18
Fox in the Henhouse: Why Interest Rates Are Rising - 23rd Apr 18
Stocks and Bonds, This is Not a Market - 23rd Apr 18
Happy Anniversary Silver Investors! - 23rd Apr 18
The Hottest Commodity Play In 2018 - 23rd Apr 18
Stock Market Correction Turns Consolidation - 23rd Apr 18
Silver Squeeze, Gold Fails & GDX Breadth - 23rd Apr 18
US Economy Is Cooked, the Growth Cycle has Peaked - 23rd Apr 18
Inflation, With a Shelf Life - 23rd Apr 18 - Gary_Tanashian
Stock Market Predictive Modeling Is Calling For A Continued Rally - 22nd Apr 18
SWEATCOIN - Get PAID to WALK! Incentive to Burn Fat and Lose Weight - Review - 22nd Apr 18
Sheffield Local Elections 2018 Forecast Results - 22nd Apr 18
How Long Does it take for a 10%+ Stock Market Correction to Make New Highs - 21st Apr 18
Sheffield Ruling Labour Party Could Lose 10 Council Seats at May Local Elections - 21st Apr 18
Crude Oil Price Trend Forecast - Saudi Arabia $80 ARAMCO Stock IPO Target - 21st Apr 18
Gold Price Nearing Bull Market Breakout, Stocks to Follow - 20th Apr 18
What’s Bitcoin Really Worth? - 20th Apr 18
Stock Market May "Let Go" - 20th Apr 18
Overwhelming Evidence Against Near Stock Market Grand Supercycle Top - 20th Apr 18
Crude Oil Price Trend Forecast - Saudi's Want $100 for ARAMCO Stock IPO - 20th Apr 18
The Incredible Silver Trade – What You Need to Know - 20th Apr 18
Is War "Hell" for the Stock Market? - 19th Apr 18
Palladium Bullion Surges 17% In 9 Days On Russian Supply Concerns - 19th Apr 18
Breadth Study Suggests that Stock Market Bottom is Already In - 19th Apr 18
Allegory Regarding Investment Decisions Made On Basis Of Government’s Income Statement, Balance Sheet - 19th Apr 18
Gold – A Unique Repeat of the 2007 and How to Profit - 19th Apr 18
Abbeydale Park Rise Cherry Tree's in Blossom - Sheffield Street Tree Protests - 19th Apr 18
The Stock Market “Turn of the Month Effect” Exists in 11 of 11 Countries - 18th Apr 18
Winter is Coming - Coming Storms Will Bring Out the Best and Worst in Humanity - 18th Apr 18
What Does it Take to Create Living Wage Jobs? - 18th Apr 18
Gold and Silver Buy Signals - 18th Apr 18
WINTER IS COMING - The Ongoing Fourth Turning Crisis Part2 - 18th Apr 18
A Stock Market Rally on Low Volume is NOT Bearish - 17th Apr 18
Three Gold Charts, One Big Gold Stocks Opportunity - 17th Apr 18
Crude Oil Price As Bullish as it Seems? - 17th Apr 18
A Good Time to Buy Facebook? - 17th Apr 18
THE Financial Crisis Acronym of 2008 is Sounding Another Alarm - 16th Apr 18
Bombs, Missiles and War – What to Expect Next from the Stock Market - 16th Apr 18
Global Debt Bubble Hits New All Time High – One Quadrillion Reasons To Buy Gold - 16th Apr 18
Will Bitcoin Ever Recover? - 16th Apr 18
Stock Market Futures Bounce, But Stopped at Trendline - 16th Apr 18
How To Profit As Oil Prices Explode - 16th Apr 18
Junior Mining Stocks are Close to Breaking Downtrend - 16th Apr 18
Look Inside a Caravan at UK Holiday Park for Summer 2018 - Hoseasons Cayton Bay Sea Side - 16th Apr 18
Stock Market More Weakness? How Much? - 15th Apr 18
Time for the Gold Bulls to Show their Mettle - 15th Apr 18
Trading Markets Amid Sound of Wars - 15th Apr 18
Sugar Commodity Buying Levels Analysis - 14th Apr 18
The Oil Trade May Be Coming Alive - 14th Apr 18

Market Oracle FREE Newsletter

Trading Lessons

The Natural Gas Trading Play

Commodities / Natural Gas Dec 20, 2015 - 06:33 AM GMT

By: EconMatters

Commodities

Bearish Sentiment

A lot of bearishness has been priced into the natural gas market due to many factors including robust production, bulging inventories, and mild weather on average across the country. Natural gas in the futures market reached a low of $1.68 MMBtu for Henry Hub on the January contract this past week. Natural gas closed trading on Friday at around $1.77 MMBtu.

These prices for natural gas are the lowest in 15 years and the questions that accompany such lows are the following: How low can prices go, do these low prices create a buying opportunity, what kind of timeframe is involved, and what is the best strategy for capitalizing on a rebound in natural gas prices.

How Low

In regard to how low natural gas can go, back in 2012 traders and analysts were talking about sub $1 MMBtu natural gas based on the fact that the derivative product`s markets related to natural gas production were actually booming for the specialty gases. Hence a producer was incentivized to produce natural gas below costs because the margins were so high for the specialty gases associated with producing natural gas in the drilling process. In 2012 natural gas for the front month contract in Henry Hub futures dipped briefly below $2 MMBtu around the time when traders were discussing sub $1 natural gas.
 

Given the fact that even the best traders and market analysts have no idea the exact low point for any market, let us just use this $1 MMBtu price for the worst case scenario for how low natural gas prices can go. I firmly believe in the rationality of financial markets in the longer term, and from this follows the old trading axiom that there is no cure for low prices like low prices. I don`t think there is that much more money to be made from the short side of the natural gas market over the same three year time frame.

Buying Opportunity

Therefore I view the current price of natural gas as a buying opportunity over a three year time horizon. I realize that I cannot predict the bottom in the market, and I am not going to try and be perfect regarding timing the turn in the market. However, I do predict given the decline in oil and gas drilling rigs, the economics of producing below longer term costs, and the fact that markets often lead the fundamentals, that this represents a buying opportunity in natural gas. I am basically buying when everyone else and their grandma is selling the natural gas market. I am sure corporations, wildcatters and trading firms are all making business decisions based upon these low natural gas prices, and they are not from the bullish side of the equation. I want to be on the other side of this trade given my three year time horizon.

Timeframe

As I mentioned the timeframe for this trade or investment decision to play out is three years. Do I think the natural gas market will put in a bullish move more towards the front end of this timeframe? I would say the probabilities are sufficient to suggest that I may be trading around a core position that has substantial profits during this 3 year time frame, as a year is an eternity in a market like natural gas. Natural gas can easily move to $5 MMBtu in a reduction in production and an extremely hot summer, followed by an overly brutal winter heating season.
 

The market can really trend, it can spike, it can retrace, and it can do all kinds of strange things. Remember two winters ago? I am confident the investment makes money over a three year time frame, and it is up to the individual where and when to take profits on the trade. It may make sense to reallocate capital after a nice fifteen month`s trending move in natural gas, or it may make sense to just ride the trade well past three years if circumstances dictate.

Upside Variables?

There are so many unpredictable variables like more Power Generation continuing to transfer from coal based to natural gas, the economy starts growing 3 to 4% instead of 2%, demand outstrips existing capacity in the electricity market, demand for a period outstrips supply in natural gas, an insane hurricane season knocking production offline and doing damage to natural gas infrastructure.

What I do know is one way or another natural gas somehow finds its way back to the $5 MMBtu level even during the shale revolution. I expect that sometime over the next three years natural gas finds its way back to this ‘natural gravitational’ market price. It may even make several trips up to $5 MMBtu over the course of the next three years. It was just over $7 MMBtu two winters ago after the last crushing of the market back in 2012 to below $2 MMBtu. It took just two short years to really move well above the $5 level.

Best Strategy

The best strategy for playing this move depends on a trader`s resources. Most traders are not going to employ swaps, options or other derivatives due to resource constraints and sophistication concerns. Investors could buy futures and just roll over the positions each month, buy back dated futures contracts, or even buy stocks highly correlated to the price of natural gas. But with bankruptcy and individual company specific concerns I would stay away from this option until more visibility on the ramifications of sub $2 natural gas plays out on companies` balance sheets.

You don`t want to be forced out of the trade due to factors outside of your control like management incompetence that wipes out your equity stake before natural gas prices recover which is open-ended to a large extent. Rolling over the futures contract may be more than the average investor is willing to stomach, and the volatility of the front month futures contract may create havoc on one`s sleeping bliss after a poor inventory report. The back month futures contracts have some premium factored into them as well, and liquidity concerns are involved.

UNG ETF

I would recommend using the UNG ETF, it has been around since 2007, has decent volume, consists of natural gas futures contracts, and roughly tracks the price of the natural gas market over the last eight years. It isn`t going to totally fall apart like some of those poorly constructed ETFs that are supposed to track markets but inevitably lose value over time regardless of long term price returns of the underlying assets being tracked.
 

In short, this instrument will do what an investor needs to accomplish to track any rebound in natural gas prices over the next three years without being margined out of the market or having to worry about timing this rebound perfectly. I would not worry about trying to scale into a position based upon price. If one is using size on this investment then a nice Algo buying program will suffice for next week`s action. We are not trying to pick a bottom here, we expect that prices can go lower, but the current price represents value for us over a three year time frame both from a trading an investment standpoint.

The question here is can I make money at these prices if I buy right now over the next three years. Am I going to be able to stay in this trade until the turn plays out in the natural gas market? And will I be able to at least double my initial investment over this timeframe if this is my longer term goal? My analysis is that the affirmative case can be made for these questions. The minimum profit goal is 20% on this investment play. An investor should not be looking to take any profits on this play until this minimum profit threshold is met.

Therefore, assuming an investor has an average position price in UNG around $7 a share, the minimum profit target would be $8.75 a share for any timeframe during this three year investment window for justifying taking off this trade from a profit perspective. This trade profile is built upon being rewarded for taking risk and providing liquidity to a market that is basically in freefall mode. A 5% profit target on the trade is just poor risk reward trade management. Keep this in mind when thinking about profit targets for this investment.

Therefore unless I have a better opportunity with the same risk to reward profile for this investment capital over the next three years then this is a good place to park some capital and put it to work for me. I realize this play seems highly contrarian in the current market environment, and this is a positive, it means that I am being paid for taking this risk, and my upside reward is what makes this play worthwhile in my trading book.

By EconMatters

http://www.econmatters.com/

The theory of quantum mechanics and Einstein’s theory of relativity (E=mc2) have taught us that matter (yin) and energy (yang) are inter-related and interdependent. This interconnectness of all things is the essense of the concept “yin-yang”, and Einstein’s fundamental equation: matter equals energy. The same theories may be applied to equities and commodity markets.

All things within the markets and macro-economy undergo constant change and transformation, and everything is interconnected. That’s why here at Economic Forecasts & Opinions, we focus on identifying the fundamental theories of cause and effect in the markets to help you achieve a great continuum of portfolio yin-yang equilibrium.

That's why, with a team of analysts, we at EconMatters focus on identifying the fundamental theories of cause and effect in the financial markets that matters to your portfolio.

© 2015 Copyright EconMatters - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

EconMatters Archive

© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules