Natural Gas Rally
Research for Online Investors

by John Dalt

3/17/11

Natural gas is rallying on the nuclear crisis in Japan.  Germany and China have taken action to review their plans for the operation and building of new nuclear generating plants.  If the world turns from nuclear, what is left?  Coal provides base load power efficiently, but carbon emissions give regulators heartburn.

The natural gas storage report for the United States came out this morning, and showed a larger draw on storage than traders expected.  The storage report this morning reports last week’s data.  Weather had been mild, leading traders to expected 44 Bcf to be drawn from storage.

The Energy Information Administration (EIA) reported 56 Bcf was used out of storage above production.  This was 27% more than the market expected.  Natural Gas is trading at $4.107 Mbtu, up $0.168 Mbtu from yesterday.

This is the storage report in graph form showing a red line for current storage with a blue band of the five year range.  We see the red line is rebounding sooner than the five year average would suggest it should.  While traders are interpreting the report this morning as bullish, they ignore the total gas in storage is one Bcf higher than last year this week and 23 Bcf higher than the five year average.  How long does it take to build a natural gas fired power plant?

Longer than our futures pricing in April, or certainly cash spot prices.  Be cautious here as this is a simple momentum play.  The traders that leave the market with more money in their pockets will be few.  This is especially true if you are looking at using the UNG etf to play natural gas spot price changes.

We have written before about the dangers of this etf.  It does not own natural gas; it buys futures contracts, and then rolls them over just before option expiration to roll over into the next month.  Tomorrow is option expiration day.  Volume on UNG is running over 250% normal daily volume.  When the etf rebalances daily, the manager must buy April contracts to back up additional shares.  The April contracts are up 17 cents higher from yesterday.  Where will spot prices be over the next month?

If the spot price of natural gas goes down, the contract is worth less.  If shares of UNG do not go down likewise, the manager must balance this by selling more shares and buying more natural gas futures contracts.  If UNG goes down more than the spot price, the manager must sell futures contracts and buy back shares of UNG to bring it in balance with the spot price of Nat Gas.  As an owner of UNG, you are locked in a ‘death spiral’ if the spot price is less than the futures contract.

The futures price of Natural Gas is almost always higher than the spot price.  This is normal, this is Contango.  We have written about it before in Contango and Backwardation.  The only way you can make money in UNG is if natural gas goes into backwardation, which is when the spot price is higher than the futures price.  This happens when there is immediate demand, not anticipated increased demand.

We do not see immediate demand in the natural gas market developing as there is more gas in storage than the five year average.  Be cautious.

There is a good trade setting up in the currency markets in the Japanese Yen etf FXY.  You would think it crazy that the Yen is moving higher when the country is in the middle of a crisis that threatens their industrial output.  Add on the Bank of Japan is pumping Yen into the economy every day.  Ben Bernanke couldn’t teach them anything.  Here is a chart of the FXY for the last year.

What is driving the Japanese Yen higher?  Citizens are raising money out of fear.  They are selling anything they can and taking Yen.  When they sell something the buyer has to pay for it.  They have to convert other currencies into Yen to satisfy the contract.  Japanese citizens have been savers and have investments to cash out.  The government is printing more money to meet demand.  The higher the Yen goes, the less competitive Japanese manufacturers are in the world economy.  The government must take action to lower the value of the Yen to aid in the recovery of the country’s economy.

You can look to short the FXY as it comes back into line. Japan hopes to enlist help from other G7 countries this weekend. They want a world-wide concerted effort to drive the Yen down.

Japan has been the third largest buyer of U.S. Treasuries.  Citizens are cashing in for safety.  What does the tragedy in Japan mean for U.S. Treasury bond sales?  We probably just lost the third biggest buyer, and the Fed is the largest buyer (until June when QE2 ends).  Bill Gross said interest rates would have to rise substantially to bring buyers back to treasuries.

We think he is going to get his wish.  Take a hard look at TBT, this etf goes up when interest rates on 20-year treasuries go up.  It has been knocked down in the last two weeks on eurozone credit concerns, Middle East conflict and the Japanese crisis.  It is only a matter of time…

To the mailbag:
So using renewable as Obama proposes will cost twice as much as coal or nuclear?---paid up subscriber T.M.

John’s reply:  The numbers don’t lie.  Solar and wind cannot even compete with the ‘retail’ cost of electricity.  We reported these numbers last year and are looking to find them again.  Hopefully tomorrow.

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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