Natural Gas Bearish Trade
Research for Online Investors

by John Dalt

11/19/10

Natural gas is a domestic market that matches supply with demand.  Natural gas wells produce year round, but the heaviest use occurs in the winter months for home heating.  Natural gas is stored underground in salt caverns.  These are generally safe and make sure the supply of gas is plentiful when seasonal demand increases.

We have written often about the increased production of natural gas and the economical use of nat. gas for electricity generation and transportation.  Where are we in natural gas availability?

This chart from the Energy Information Agency (EIA) shows natural gas storage for the last two years, in Billion Cubic Feet (Bcf).  The broad blue shaded area paints the five year average range.  The red line is actual storage, plotted on weekly reports.

Since 2008, actual natural gas storage has remained in the upper part of the five year range.  Most of the time, actual storage reports are at the very top of the shaded area if not above it.  Last week’s build in inventory was smaller than in the past, as the country had cold weather in the southeast.

Natural gas is enjoying greater use in manufacturing and electrical generation because of its low price and low green house gas emissions.  Even with increased usage, natural gas in storage is, and has been plentiful.

“Maximum End of Month Working Gas Inventories” (MWGI) is the maximum volume of gas reported by region in the lower 48 states over the last five years. MWGI is reported by EIA as 3,833 Bcu.  Last week’s working gas in storage reflected on the above chart is 3,843, ten Billion cubic feet over any prior end of month report.

Short conclusion.  Storage is full.  It ain’t going to get any fuller.  What do you do?  Short UNG, the U.S. natural gas etf.  Understand, this is not a sure bet, but I will show you why it is a good bet.  UNG does not own natural gas, it owns futures contracts one month out for delivery of natural gas.  Natural gas is in a condition called “Contango.”  Contango means a commodity is priced higher in the future than it is in the cash spot market.

This is a normal market.  Futures markets generally reflect the spot price plus interest and storage to hold the commodity for future delivery.  They jump or dive from this price based on outside events or news, like weather or supply disruptions.

It appears, and we believe, there is more natural gas than demand because of technological advances in finding and extracting natural gas (shale gas & directional drilling). There is enough gas to meet demand and keep the red line on the graph in the top of the range, suppressing any price increase for nat. gas.

The price of natural gas is low, hovering around $4 per (million british thermal units) MMbtu.  Here is the December contract quotes for natural gas.

It has moved a little higher in the last two weeks on the forecast for colder temperatures.  Why is this good for us?  Earlier we said UNG does not own gas, it owns contracts.  When a market is in Contango, UNG buys future contracts at cash plus interest & storage, the contracts fall in price then to match the spot price.  This puts UNG in a “death spiral.”

Every contract they buy for natural gas depreciates in value to the spot price.  They lose money every month!  Here is their chart.

Looks like a giant slalom!  The danger in this trade is the spot price of gas moves higher than the futures contract price.  This puts the market into a condition called “backwardization.”  UNG will make money on contracts if this happens, and move higher.

Be careful to buy on the tops and ride the slope down.  Watch for cash spot prices in natural gas to move higher.  It could catch you.  You should be able to make money on this trade.  If you like it, but feel you need help to find trades like this, check our SwingTrader service.  We are short UNG right now.

“The Ben Bernank” slammed the Chinese for tying their currency to the dollar this morning in Germany.  We refer to him as “the Ben Bernank” because of the link to THE VIDEO on his name.  It is too funny not to watch again.  As we have written before, there is a simple way to stop China from undervaluing their currency.

Start buying Yuan. Buy yuan until you drive the price up. Buy until they cannot stop the value from rising. Of course that would mean we would have to quit selling dollars, and that would mean we would have to quit deficit spending. And that means Obama could not institute more ‘world improver’ remedies to fix all he thinks is wrong with the U.S.A.

Buy why think like a capitalist, it is easier to whine, and extend unemployment, provide free health care, and load more regulation on the economy until it comes to a complete dead-in-the-water stop. We are almost there, maybe the EPA can finish off the job the president’s men have started. He has control of health care and banking, now if he can just get energy, the trifecta will be complete.

With that thought, have a great weekend.

To the mailbag:
Does Pravda honestly think we, in this once great country, will allow Marxism to take us down?--- subscriber G.N.

John’s reply:  Obama, Pelosi and Reid already are.  Haven't you noticed?  Read the John Wayne quote again, would a citizen of our country have allowed a government employee to touch their private parts to travel 100 years ago?  50 years ago?  Ten years ago?  Would people have demanded unemployment for two years?  National health insurance?  That we all wear our seatbelts?  They outlawed Happy meal toys in San Francisco!  We can’t smoke a cigarette within 10 feet of a building!  Would they have elected an open communist to the House of Representatives?  I am with you, but don't think one vote made a difference.  These creeps have destroyed our Republic, and will continue until they are shamed and stopped.

I have got to say that with you the byword is not “Lucky Trading”, instead it is “Lower your risk and make a profit.”---Long Term subscriber R.A.

John’s reply:  Thanks for the compliment.  I try to execute a disciplined investment plan.  The funny thing is...it works most of the time.  I have made many mistakes over the years, but the more I learn it just feels right to be calm and patient.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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