Natural Gas Fundamental Analysis – Forecast for October 2016

The natural gas market featured a wicked two-sided trade with a strong bias to the upside during the early part of the month and a relentless break into the end of the month. When it was over, the November futures contract was trading $2.906, down $0.097 or -3.23%.

After seasonal selling pressure drove the market into $2.802 on September 7, the market went on a spectacular rally, driven by the return of warm temperatures and a massive short squeeze that drove prices into a multi-month high at $3.166 on September 22. From there, it was downhill all the way as the market retraced more that 61.8% of the range to finish with momentum clearly to the downside.

The catalyst behind the rally was the fast pace the natural gas glut in the U.S. was being trimmed. The cause of this rapid decline in inventory was the hotter-than-average summer in much of the U.S. and the lingering heat that carried over into most of September.

Additionally, hedge funds during September held the largest bet on rising prices in two years, as less gas had been pumped into storage ahead of the winter months.

The natural gas market sold-off sharply into the end of the month, but this wasn’t necessarily tied to bearish numbers from the U.S. Energy Information Administration. It was mostly related to a dramatic change in the weather from lingering heat to cooler temperatures. I know it sounds strange since it is October, but we are currently in a weather market. Typically they take place in the summer and winter, but this year, it has extended into the fall.

At the end of September, the EIA reported a 49 billion cubic feet build for the week-ended September 23. That compared with the average rise of 54 billion cubic feet expected. Total stocks now stand at 3.6 trillion cubic feet, up 90 billion cubic feet from a year ago and 220 billion cubic feet above the five-year average.

FORECAST

The key to trading natural gas is to stay away from the front month. In my opinion, it is the most volatile. Additionally, if you want to take advantage of longer-term moves, moving from contract to contract, month to month, doesn’t allow you to go the distance because the short-term swings are too volatile to establish a safe position.

I’m saying this because I believe the natural gas market is set up for a strong rally this winter. However, you won’t be able to take advantage of the impending rally if you are trading to close to the nearby contract. That being said, start watching the March contract because this will allow you to take advantage of a winter weather market that could take prices higher for several months. Based on some weather services, this winter may feature a return of the same polar vortex that hit the U.S. in 2014-15.

Now that inventories have been trimmed from their record highs earlier in the year because of the relentless summer heat, the natural gas market may be primed for a big rally later in the year. Based on early forecasts, we may even start to see below average temperatures as early as November.

At this time, the natural gas market is all about price action and positioning as the hedge funds and professionals are trying to drive the small speculator out of the market. This sell-off at the end of the month may have been enough to take out most of the weak longs so we’ll be looking for bottoming action early in October.

To sum it up, we’re expecting cooler temperatures to arrive early this year and for a lingering cold system to hit at some time this winter. We saw a draw down in supply even though it is still near record levels. We’re seeing producers cut back on production. All of these factors add up to a potentially bullish market this winter.

October may continue to see choppy, two-sided trading as the players jockey for position ahead of the winter. This would be considered a normal trade for the month because it typically isn’t too cold or too hot to change the demand picture. However, pay attention to the charts to see if a support base is being built.

If we are right and the winter is colder than average then based on current storage levels, we could see a supply deficit in March and this would be a bullish development.