Natural Gas Is The Mania De Jour
The following is an excerpt from commentary that originally appeared at Treasure Chests for the benefit of subscribers on Monday, April 27th, 2009
Many are wondering what the heck is going on in the natural gas (NG) market, because if it's suppose to be such an essential commodity, why does the price keep crashing, especially with stability found in the larger equity complex? To answer this question properly, we must first set the stage with the appropriate background understandings, where because of the extremes in pricing we are seeing here, previous efforts in this regard now appear insufficient. In the first place, in order to fully understand what is occurring here, one must realize that the NG market is now showing all the signs of an extreme manic blow-off, only instead of an upside exhaustion, we are witnessing a 'selling panic'. In this regard then, the important thing to realize is extremes in speculation and emotion are now in control of this market, not the fundamentals, making it the 'mania de jour'.
When I say fundamentals, what I am referring to here is not the mechanical futures related trading constraints that characterize our faulty and fraudulent pricing mechanisms, with Nymex being central in this regard. No, that is largely how we got into this mess, where I say 'mess' because the longer wrong-headed speculators and faulty pricing mechanisms keep prices down, the more long lasting the damage will be, which will eventually cause an equally manic reaction higher in price. And this will likely occur just when we do not need it, where we could stand to see the extreme sell-off correct right now to avoid such price swings in the future. Be that as it may however, and for whatever reason you wish to discuss, with the propaganda machine widely discussing the expectation of increasing inventories through summer due to expected cooler than usual temperatures now, prices continue to fall, with no end in sight being the central perception at present.
And you know what, prices will definitely continue to fall into early this week for reasons I will discuss in just a minute, or longer due to other unforeseen factors. Suffice it to say however, no matter what happens in the NG market moving forward from here, prices have already witnessed an epic sell-off measuring 75% straight down with no bounce to speak of since last summer, and a very negative tone has now gripped the market that has proven to be sufficient to panic people out that have likely rode much of the decline down, which is of course a necessary prerequisite in terms of the sentiment that is needed to affect a turn. We know this to be true not just by the panic selling last week set against a generally buoyant equity complex, but the noticeable rise in post expiry open interest put / call ratios on the United States Natural Gas Fund (UNG) discussed last week, indicating that finally bullish speculators / hedgers have become exhausted, which again, is a necessary precursor to a turn around.
You will remember from previous discussions on the subject, this was the necessary precondition for turnaround in the stock market, kicking into full gear with marked increases in post expiry US index open interest put / call ratios after the March expiry, with the pertinent charts attached here. Of course the thing about NG is as opposed to the stock market, it has become the 'whipping boy' of not just crazed hedge fund managers who continue to add to their speculative short positions; but also, one must remember politicians are looking to push through cap & trade right now (this has been scuttled now), where lower commodity pricing will be used as partial justification for such a move. So, don't expect to see any friendly inventory data coming out until it can no longer be avoided, where last week price managers needed to see a big build, and magically (heavy on the sarcasm), that's exactly what they got. This, while prices were plumbing $3.50, which is the threshold many producers will need to begin shutting in much of their production.
So you see, misinformation and emotional capitulation are the primary reasons NG prices continue to collapse, where instead of focusing on immediate storage estimates (the key word here is estimates) and wrong headed propaganda, the market should be looking at the fact not only has the vast majority of exploration and development been put on hold, production will now be increasingly shut in as prices continue lower, which at one point or another will factor into the formula. And the thing to realize about exploration and development or shut-in related supply curtailment is once an operation is shut down, it's not brought back on line quickly. No, no, no. After seeing the market melt down like it has over the past 10 months, it's important to understand that those operators who do not need the revenue to pay debt will be reluctant to spend the money to bring this production back on line before a big price increase is witnessed, which will do nothing but add to the dominant fundamental that is leading us into the future, that being peak oil, and the fact that increasingly, accelerating depletion rates for crude oil will weigh heavily on any present excess NG capacity.
Just how long it takes for the larger fundamentals to kick in are of course not certain, but the important thing to remember is a SHARP DROP in inventories will hit the market at some point, and because of peak oil related considerations, supply will likely remain an issue on a PERMANENT BASIS in the long-term. In the meantime however it seems all the market wants to focus on is the sluggish economy (declining industrial demand), an anticipated cool summer, and building inventories, but this will change. And as mentioned above, sentiment has finally turned amongst the ETF speculators, which has been a reliable indicator in the past with respect to commodity price movements because aggregate futures contract distributions are no longer structured in a conducive manner to support lower prices, this being true in spite of the fact further out months are not factoring in anticipated price increases until fall. Here, it should be realized this just part and parcel of the speculation game, where a lasting price spike higher would be sure to bring a steepening curve given time.
Further to this, based on the extensive reading on this subject I have been performing in preparation for writing this report, nobody, and I mean nobody other than me is tuned into this options related sentiment change, which does two things. First, it explains why prices can continue lower into this week since we are still three-weeks away from expiry. And two, it's also very telling when put against the light many conventional analysts and the public are now unanimous about the outlook NG should continue trending lower into summer, at a minimum. The fact NG has already declined 75% in a straight line over just 10-months doesn't factor into the equation for these types just yet, but that's ok because the market will need dupes to both buy and short NG at higher prices to keep a rally going longer than anybody expects as well. What's more, and now that we have what I think is an appropriate backdrop developed, it's time to look at the technicals in an attempt to confirm what must appear to be radical views by most market participants at this point. (See Figure 1)
Of course what is really radical is the Chart below, where as mentioned above, NG has been declining in a straight line for 10-months now, and is about as oversold as any market should ever get even under the most bearish of conditions. And this is certainly the irony with NG at the moment, because as also mentioned above, the primary long-term fundamentals for NG could not be better, where the only reason it's trading where it is today is because of our faulty and fraudulent pricing mechanisms that are largely based speculator behavior. That being said, one would be foolish to think the bears and price managers will be able to keep their bad acts up for mush longer all things considered, where although the ratio related plots below all leave open the possibility of further relatively small losses in the short term, once reversals do occur, it should be noted that multiyear / high degree corrections of the A - B - C variety will have been completed, which means multiple years of NG outperformance against every commodity / equity on the planet will likely take hold. So you see, not only does NG have a strong fundamental backdrop that extends into the long-tem; but also, the technical picture could not look better in this regard as well. This first picture here is NG set against crude, which is extending a minor degree fifth-wave down into the bottoming range that has been established over the past few years. (See Figure 2)
While its possible NG might need to extend to a new low against oil, I wouldn't bet on it all things considered, and especially if a severe swine flue pandemic breaks out. In fact, given the circumstances, I would hazard a guess NG is likely seeing the lows against crude right here, with both stocks and gold to follow later in the week. And while it's also possible all assets begin to decline once again soon if stocks take the widely anticipated plunge just about everybody is expecting right now (making such an outcome unlikely from a contrarian perspective of course), which would be a drag on NG too, it should be noted that price swings associated with the sentiment related reversals discussed above normally involve nominal price reversals also. Of course if gold is to continue higher in the longer-term, which we fully expect, such considerations should appear moot to even the most uptight of investors in fairly short order; where again, if NG is slated to begin outperforming the yellow metal anytime now, which is the big message being thrown off by the chart below, future returns would more than compensate for any short-term discomfort experienced. (See Figure 3)
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