HardAssetsInvestor

Written by Amine Bouchentouf  |

August 07, 2012

The Commmodity Investor: NatGas Still Has Room For Further Upside, But Prepare To Exit At $3.40

Details

Taking a cautiously long position on natural gas can create opportunity; beware of the $2.80 support level.

Since I recommended going long natural gas in late June through the United States Natural Gas Fund (NYSE Arca: UNG), the ETF is up almost 10 percent, outperforming many commodities during this time frame.

At the time, the rationale was fairly straightforward: Prices had reached such a low that they actually risked going negative. There was so much excess supply that producers were close to starting to paying customers to buy their natgas. While that wouldn’t practically happen, the fact that some market analysts even started predicting negative prices meant the market had reached a bottom.

In addition, faced with historically and abysmally low prices, the industry banded together and decided it was going put in place measures that would stem this downward spiral. Many producers began to shut off production and kept natural gas off the market in order to stabilize prices. These concerted efforts worked, and natural gas prices rallied dramatically as a result.

Furthermore, natgas prices were (and arguably still are) at such historic lows that they began a trend of substitution, whereby electric power plants began switching from coal to the cheaper natural-gas alternative. This substitution created a new stream of revenue for natgas producers as electric power plants began ramping up their orders, spurred by the historically low prices.

What’s Next?

Let’s put this in perspective again. Despite the rally we saw in late June and throughout July, natural gas prices are still trading at historically low levels. Prices are currently trading near the $3.00/mmbtu range, and we may be seeing a further plateauing of prices before we get a clearer indication of things to come. What’s certain is that natural gas prices will continue to fluctuate fairly aggressively. That’s the nature of the beast.

That said, prices are biased toward the upside simply because they are trading at extremely low levels and there are several bullish factors at play.

Another critical factor we need to monitor closely is the weather. Agricultural traders and investors are already very familiar with the drought that’s been wreaking havoc in the continental states. This massive and historic drought in the U.S., which we haven’t seen since the 1950s, is having a dramatic impact on prices for all sorts of natural resources, least of which is natural gas. A lot of the volatility that’s inherent to natgas is sometimes attributed to weather patterns. Indeed, natural gas prices react very directly and sometimes very violently to changes in the weather.