At the Metal Augmentor, we're constantly evaluating investment and speculative opportunities within the commodity sector. Natural gas recently piqued our interest as a potential speculation based on what appears to be a bottoming pattern and positive cyclical factors in the months ahead, so we asked our associates at Eidetic Research to prepare a technical analysis evaluating the likelihood of a sharp spike in natural gas prices. Although our intuition tells us that the time to get on board will be soon, we are waiting for the technicals to turn positive before making any large bets in natural gas. One prospective way to maintain some natural gas exposure without deploying a significant amount of capital is far out-of-the-money call options in the NYMEX futures contract.
Natural Gas Market Technical Analysis
by Eidetic Research
Among the various commodities markets, the energy complex is, arguably, the most consistent in its seasonality. Generally speaking, prices tend to advance from a spring low to an autumn high. The natural gas market, although similar to energy markets that are petroleum based such as crude oil, heating oil and gasoline is also prone to seasonal moves but it follows its own script. The interplay of weather conditions and supply factors is a major force in determining price levels but natural gas, unlike the petroleum based markets, appears to be more susceptible to cyclical conditions than to seasonal factors.
CHART I
The above monthly continuation chart illustrates the cyclical nature of the market. The chart dates from 1990 when the futures market for natural gas was initiated. We have arbitrarily annotated what we consider to be cyclical highs in red while sub cycle highs are in black and cyclical lows are shown in blue. A casual examination of the chart shows that prices make occasional large upside forays but that there is no periodicity in those moves. Note that in the first 5 years, the market was confined to a relatively narrow range with lows just above $1/MMBtu and highs below $2.80/MMBtu. In December 1995 a new price peak was made at $3.72 basis the active nearby NYMEX futures. From then on, particularly in the past 10 years, the market developed a tendency toward progressively larger upside cyclical upswings: $8 to $10 advances, worth $80,000 - 100,000 per futures contract, have become the norm during the up part of the cycle. That leveraged potential makes the market especially attractive as a trading vehicle since there are few commodities markets that are capable of moves of that magnitude.
At this time we are neutral as to whether or not the market is readying another move on the upside. However, we will discuss some of the factors that we see that could favor such a scenario. Referring again to the monthly chart above, we see that the stochastic indicator (14-period) is generally flat in the neutral 50 area. The indicator has been waffling back and forth since January 2010 but the black %K line is currently below the blue %D line which imparts a marginally negative momentum aspect to the overall picture. Regarding the cycle highs, since the initial foray into new high ground in 1995, there have been 6 major cycles. Four of those peaked in December, one in February and one in July. Cyclical lows since 1995 also total 6 if we include last year's low. Five of those lows occurred in September and one in February (1997). From a strictly subjective and simplistic interpretation, we can say that major price lows in natural gas usually occur during the month of September.
Moving on to the weekly continuation chart below, we can see that the 14-period stochastic indicator is presently declining. Values are below 30 so intermediate-term momentum conditions may be termed "oversold" or favoring a price low. The red %K line is above its late-August low so an upturn in the indicator may be pending. There is an unconfirmed bullish divergence relative to the April - May price/indicator lows. On balance, the weekly stochastic presents a potentially constructive picture at this time but some price strength in October is necessary to move the picture from potential to actual.
CHART II
Drawn on the weekly chart itself is a series of parallel lines. This analytical approach is not common and may be uniquely ours for all we know but we have found it to be of uncommon value in certain circumstances [applied well in advance to the gold market it was instrumental in our looking for a major price low around $729 during the late-2008 collapse (actual low was $696.60)]. The blue line A is our base line that is drawn through the lows of 1992 and 1999. Parallel to it and drawn from the 1996 high is line B. A potential equilibrium zone between those lines is that shown by the dashed cyan lines. Above and parallel to line B is green line C and above that, again parallel, is green line D. The vertical distance between line C and line B is equal to the vertical distance A - B and the vertical distance between line C and line D is equal to the vertical distance A - C.
The four lines A, B, C, D represent potential resistance areas when prices are rising and potential support areas when prices are declining. The lines were drawn in 1999 but have proved to be operative with respect to where we would expect interim price highs and lows to occur. Currently, prices are oscillating around $4 which is roughly coincident with the cyan equilibrium zone in the original A - B channel. At this time we have 4 values associated with where the four lines cross: below the market at $2.67 and above the market at $5.87, 8.99 and 15.28. The last 3 represent potential consolidation or topping areas for the next upside price cycle but of those we think that line C represents the most probable top area since it marks the approximate middle of the entire A - D zone.
Our final chart below is a zoom-in on the above weekly continuation chart. Illustrated is the 40-week moving average (proxy for the popular 200-day moving average) and the stochastic indicator. As we discussed above, the declining stochastic values are above their April - May lows while prices are below their respective lows. Thus, an unconfirmed bullish divergence exists. Prices are below a short-term downtrend line (ST at about $4.80) as well as their long-term moving average at $4.63 which itself is declining. Those are negative factors. The ongoing decline from a January high (the start of the short-term downtrend line) has reached a Fibonacci-related 61.8% retracement - shown at $3.79 - an area which could be supportive if a trend turn is in the works.
CHART III
In summary, the natural gas market occasionally develops technical conditions that are precursors of a cyclical advance that is usually of substantial proportions. Currently, when we survey intermediate- and long-term technical conditions we can see the prospect that the market may now be bottoming around the $3.80 area basis the NYMEX front month futures. However, we just do not see a confluence of indicators that would provide us with a greater degree of certainty as to a pending price advance. We think that this is one of those instances where we need to let the market tell its tale: generate enough strength to turn the weekly stochastic values up, thus confirming a bullish divergence, and then trade above the moving average/downtrend line resistance zone at $4.63 - 4.80.
Eidetic Research
September 16, 2010
This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any commodity, futures contract, or option contract. Although the statements of facts in this report have been obtained from and are based upon sources that are believed to be reliable, we do not guarantee their accuracy and any such information may be incomplete or condensed. We do not assume responsibility for typographical or clerical errors in this report. All opinions included in this report are as of the date of this report and are subject to change without notice. Employees of Eidetic Research may hold positions in futures or cash markets that are either in accordance with, or contrary to, stated conclusions within this report.
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