04-01-2008: May Natural Gas: Cost of Storage Works Against Long Positions
Soaring commodity prices have driven our programmers nuts trying to keep our antiquated software able to handle decimal point placements. Natural gas prices are no exception. They have been all over the map causing some of our programs to crash. Zenith's antiquated systems use integer formats, an outgrowth of the old days when memory in computers was expensive and in short supply. We will probably never change from that. But it does introduce some confusion in our articles regarding different decimal placements for varying sources. Generally, when a commodity trader verbally puts in an order, he justs spews off the numbers without decimals, the latter being "understood." With on-line software, the situation may be vastly different.
But our "problems" analyzing energy futures go beyond that. Early on our management made a decision to use data adjusted for forward contracts rather than using continuous contracts. The mathematics was easier, so our charts took discreet jumps whenever we adjusted to a new contract, with older prices being adjusted to the new ones. Therefore, the cost of storage or the "cost of carry" cumulated on our charts, and within three years our historical data seemed all out of whack. Actually, it was not, because the day-to-day relationships in price remained virtually identical to continuous contracts (continuously forward-adjusted), but over the long haul, the cumulating cost of carries (which real traders had to pay every time they moved a contract forward) showed a huge historical price not reflected in actual prices. We still believe this data is actually better for use in making predictions, so we do not apologize for it. It reflects the true cost of commodity contracts rather than the commodities themselves, and warns a trader that the he can lose significant amounts of money by not considering the "cost of carry." Under that scenario, prices fall much faster than in the real world.
To illustrate, the two graphs below show natural gas prices, non-adjusted above, and our adjusted data below. You can see a huge difference generated over recent years.
Our point in this is to suggest that traders must figure in the cost of storage when trading natural gas. It is always working against them in holding a commodities contract long, and working for them in a short sale.
Part of the culprit is the way in which our country's two major financial institutions, the Federal Reserve and the Treasury Department have mismanaged the economy, giving in to big business and big investment house interests, propping up the market with "quick fixes," and allowing the U.S. Dollar to become a weak third-world currency. Inflation is out of control. Somehow, natural gas has not experienced quite the degree of inflation as other commodities, at least not lately, although earlier moves were all over the map. But natural gas remains an attractive target for big utilities who may find it cheaper than crude oil to burn in electric steam generating plants. Certainly natural gas is environmentally more friendly than coal or crude oil. Therefore, most analysts think it is only a question of time before natural gas prices soar once again.
It is no coincidence that the highest use of natural gas is in parts of the country near where it is produced, i.e. the Gulf of Mexico, and therefore, where it is cheapest.
May Natural Gas:
May Natural Gas:
The most recent natural gas storage report showed a draw of 36 bcf, below market expectations and not providing support to natural gas prices. A milder weather outlook is also not supportive. Even strong recent crude oil prices have not provided corresponding support to natural gas. World demand for crude oil does supply support to natural gas prices, but any weakness in crude oil demand will surely be reflected in weaker natural gas prices. The natural gas in storage at 1,277 bcf is above the 1,244 five-year average. Most analysts believe declining Canadian production, lower LNG imports and natural gas as a cheaper alternative fuel to oil products support increasing strength in the market. Current natural gas stocks are 428 bcf below the weekly 11-yr high and 617 bcf above the weekly 11-yr. low. In the State of Washington, a proposal by Northwest Natural Gas to "decouple" energy-saving incentives from the pricing structure, was greeted with skepticism by the Washington Utilities and Transportation Commission. Northwest Natural Gas points out that customers in Washington have been paying much less than its customers in Oregon. Zenith has been critical of Washington State Government and the U & T Commission in particular ever since it allowed Washington Water Power to default on its nuclear plant bonds leaving widows and orphans holding the bag and increasing borrowing costs for every utility in the nation. Political decisions like that one are never in the public interest. Liquified petroleum gas prices have actually dropped in the Philippines in spite of much higher crude oil prices announced by major oil companies operating there. The reason was reduced demand for LPG. Much of higher energy prices is due to a falling U.S. Dollar. There are worldwide concerns that future rates of production may not keep up with demand for natural gas. The Department of Energy (DOE) released its statistics in mid-March saying that underground storage levels were 3% above the five-year average but down 16% from a year ago. The DOE estimated daily use of 63.6 bcf per day. The biggest consumers of natural gas in the nation are Texas, Oklahoma, Louisiana, and Arkansas. These are followed by upper mid-America states. Our assessment of the news is that U.S. Dollar concerns and declining production offset weather, increased storage, and any hope of reduced crude oil cost. Therefore, we would rate the overall news as supportive for natural gas prices.
10.0I R 3/28
I NYME- May-08 Natural Gas Mini 2.5KmmBTU .c/ Cm.=0.01 Lim.= 0.8
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Our computer says a non-conventional reactive interpretation of point-and-figure chart signals works best for Natural Gas. Therefore, the above chart is taken as giving a sell signal.
We are headed toward a cyclical high and a seasonal down period.
Our best-performing internal program is "Trader." It is a very "reactive" program originally developed for trading meat contracts, and shows how natural gas responds in an oscillatory fashion rather than a trending one in the short term. It is giving a buy signal.
Results of "Trader" for Natural Gas (blue lines = successful trades, red, unsuccessful): (Always in the market.)
Our third system has triggered a sell signal. (Note, disregard the year date on the chart. Our regular readers know this is not a Y2K-compliant system, but it still works.) The reason for the last buy signal arrow on the chart is a bit unclear, given the chart. This is canned software not written by us; we have to assume the last signal is invalid.
The point value is $10,000. Readers are advised to use mini contracts. Initial margin on a single maxi contract is $8,539. Use of options is advised.
If we discount the blip in 2005, scale trade sellers are believed to be entering the market for the long term.
In the chart below, the yellow line is the futures price, read on the right axis. All other colors are read on the left axis. Red is small speculators. Green is large speculators. Blue is commercials. Large speculators with the best track record are getting increasingly-long.
The average volatility shown below suggests that the last major change in direction to up at a volatility low point remains intact.
Our option trade recommendation is to sell the Natural Gas July 10.2 Put @ 0.847 or better.
Here's an intraday chart for the previous day ( 3/28 ).
Risk Versus Opportunity Report
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NGK8 May Natural Gas
High Price: 1145
Current Price: 980
Low Price: 901
Risk: 0.154
Opportunity: 0.323
(O/R) Ratio = 2.089
Level Table:
| Factors | Weighted Points |
|---|---|
| Parabolic Chart | + 1 |
| Nirvana Chart | - 1 |
| News | + 1 |
| Point & Figure | - 1 |
| Cyclicals | + 1 |
| Seasonals | - 1 |
| Internal System 1 | + 1 |
| Internal System 2 | 0 |
| Third System | - 1 |
| Commitment of Traders | + 1 |
| Historic Range | - 1 |
| Range/Volatility | + 1 |
| Level Table | + 1 |
| Other Factors | + 1 |
| Total | + 3 |
Place 1 May Natural Gas on a Buy Watch with stoploss @ -0.81 below the get-in point.________________________________________________________________________________________________________R.S.
