Finding a Bottom in Natural Gas

Andy Waldock |

The natural gas futures market was trading above $5 per mm/btu one year ago. This was boosted in large part by one of the coldest winters on record. Frankly, the news in natural gas since then has been nothing but bad as a mild summer limited cooling demands and the still temperate winter has brought more of the same. Furthermore, the sharp drop in oil prices along with a growing supply glut have also combined to send prices to multi-year lows. Several bearish factors have beaten the market down 50% from last year's high. In fact, the gravity of the market has finally forced it to fall below the technical support on the chart below that had built up since the market last bottomed in 2012. However, all is not lost.

Big picture look at natural gas futures. Where we've been Where we are. Where we're headed.

Commercial long hedgers have come into the market in a significant way four times in the last five years. Their first major move came in 2011 when they set their record of net long approximately 229,000 contracts. The market then rallied more than 15% over the next 8 weeks. There was another build into January of 2013 which preceded a rally of nearly 35% by April. Even more dramatic was the build in the commercial position preceding the November - February rally of last year which approached 60% at the height of the Polar Vortex.

The current build in the commercial trader position eclipses the previous two builds and puts the market within striking distance of the 2011 net long record. Furthermore, each of the previous rallies was triggered by a bullish technical divergence. A bullish divergence occurs when our market momentum indicator fails to make a new low along with the futures price it tracks. You can see the divergence on the chart below along with the actual trading signals this trading strategy has produced over the last two years in the natural gas market.

Two years' worth of COT Signals' discretionary trading strategy in natural gas futures.

The last piece to look at is seasonal analysis. Based on what we're looking for, the April natural gas contract will allow us to stay in until March 26th. There are two important aspects to this. First of all, the current structure of the natural gas market is growing more imbalanced by the day. The large speculator category of the Commitment of Trader reports is made up primarily of trend traders. The downward trend has been working for nearly a year. This has attracted even more short positions. The recent fall through technical support further bloodied the waters. These positions will most likely be closed out prior to the March expiration. The re-purchasing of these contracts should boost support as long hedgers are fully ready to take delivery at these prices while large speculators must offset their positions. Secondly, the timing of the predicted action lines up perfectly with the April natural gas seasonal chart from Moore Research Center as seen below.

April natural gas futures seasonal behavior by Moore Research Center.

We see natural gas being dragged lower in the short-term by overall weakness in the the stock market and the commodity sector with a special emphasis on energies. The technical damage that has been done to this market does not match the fundamental picture that the commercial long hedgers are trying to show us. This could very well be a classic case of program traders following black boxes versus the collective wisdom of the commercial traders' boots on the ground view of things. We believe that the odds of a successful trade returning a good percentage are increasingly on the long side through the next several weeks. Therefore, we'll be actively looking for the bottom and publishing the corroborating evidence as it materializes.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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