Saturday, February 22, 2014

A Profitable Opportunity to Short Natural Gas Is Near

Natural gas prices, long stuck at about $3.70 per mmbtu, have shot up to over $6 this past week due to the cold weather in the US.  Momentum traders and hot money are also jumping into this commodity trade, pushing prices higher at the commodity exchanges.  But there is an opportunity for the average investor, like you and me, to make a very profitable trade using ETFs in the stock exchange to capitalize on a reversion of nat gas prices back to $4 or so in the weeks ahead.

Natural gas prices have soared in recent weeks as we've had a cold winter.  Stored gas volumes have sharply declined in recent weeks as would be expected for extreme levels of demand due to the extreme cold weather nationwide.  From the EIA on Feb 11, 2014:
Cold weather also contributed to a new record-high withdrawal of natural gas from storage and a surge in natural gas spot prices. Natural gas working inventories on January 31 totaled 1.92 trillion cubic feet (Tcf), 0.78 Tcf below the level at the same time a year ago and 0.56 Tcf below the previous five-year average (2009-13). Henry Hub natural gas spot prices increased from $4.32 per million British thermal units (MMBtu) on January 2 to $5.66/MMBtu on January 27, before falling back to $5.04/MMBtu on January 31. EIA expects that the Henry Hub natural gas spot price, which averaged $3.73/MMBtu in 2013, will average $4.17/MMBtu in 2014, an increase of $0.27/MMBtu from last month's STEO.
Natural gas prices rose to $6.00 per mmbtu this week. This is a phenomenon seen in past years but not since 2008.  The graph below shows Henry Hub natural gas prices in recent years. Today's price of $6 is hardly extreme but is significantly higher than last year's average price of $3.70.  But you can see that prices could go much higher due to additional speculation.

Henry Hub Natural Gas Spot Price
However, the extreme cold weather will not last and natural gas prices will fall back closer to $4 in the months and even weeks ahead.  March is almost here and the end of winter is officially March 21st.  Meanwhile natural gas production continues to ramp up due to the shale gas/oil phenomenon (see charts below).  Also, high prices will very likely stimulate gas production from marginal wells that may have been shut-in due to previously low prices

Overall US gas production has been flat-ish due to sluggish demand and low natural gas prices. Here's some graphs from the EIA (see here):

But shale gas from the fracking revolution keeps growing and offsets declines in other producing areas. 

Now, the Natural Gas Investment Idea

My investment idea is to short natural gas prices when speculative extremes are reached in the days ahead by using some NYSE traded ETFs.   Keep watching natural gas prices.  Extreme (parabolic) daily natural gas price increases are probably a good signal of a blow-off speculative mania.  Also, watch for weather forecasts that indicate that national temperatures will return to more normal levels. Short positions (to profit from decline in share prices) should be taken to capitalize on prices that will surely revert to the recent mean.

Fortunately, short or inverse commodity ETFs, including natural gas, are available for the average investor. Since it's difficult to spot the exact peak in natural gas prices, it's probably a good idea to accumulate one of the inverse ETFs shown below as prices race higher.

The two charts below show two short ETF funds: DGAZ and KOLD.  DGAZ is a triple inverse (short) natural gas price vehicle has more volatility.   Notice that during normal weather last fall, DGAZ traded between 13 and 17. It is now trading at 2.81. If it DGAZ returns to 13, then you'd see a 4-fold increase in your investment.  At $2.81, the price of DGAZ is similar to a stock option!

The other inverse natural gas ETF is shown below. See below for the chart of KOLD.  With KOLD trading at 39 last friday, than a return to a level of 90 last fall would give you a 3-fold increase in your investment:

Good luck with your investments.  Remember, betting that warmer and more seasonal weather lies ahead is hardly much of a speculation!!  I think the ideas above represent a good opportunity.

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