Natural Gas Fundamental Forecast – September 26, 2016

After a squeeze drove weak shorts out of the market and prices to multi-month highs, natural gas prices tumbled erasing all of the week’s early gains. When the dust settled on Friday, November Natural Gas futures were trading $3.013, down $0.048 or -1.57%. For the week, the futures contract off 0.26%.

The selling pressure was fueled by both technical and fundamental factors. Technically, sellers were following through to the downside following the previous day’s potentially bearish higher-high, lower-close chart pattern.

Fundamentally, investors were reacting to a slightly higher-than-expected inventory build the week-ending September 16 as reported by the U.S. Energy Information Administration. Additionally, sellers may have also been influenced by a change in a weather forecast that called for cooler temperatures.

There may have been a little more to the huge sell-off than a reaction to the fundamentals, however. And that comes from knowing a little about price action. My comments earlier in the week identified a market that was ripe for a short squeeze, I could see it coming because I saw what was going on in the Commodity Futures Trading Commission’s Weekly Commitment of Traders report.

The report showed that hedge funds were building a huge long positions and that short-sellers were covering aggressively. Once the hedge fund buyers had driven the market into a series of previous tops at $3.060 to $3.067, they had no choice but to drive the market through these levels to take out most of the remaining shorts. They put the “squeeze” them.

It is often said that a market will rally until the strongest short-seller is taken out. And I think that is what happened late last week. The price action suggests that new buyers weren’t coming in on the rally, but that old shorts were coming out. Without anyone left to sell to, the hedge funds just decided to get out of some of their positions and the rout started.

FORECAST

Last week’s drive to levels not seen in months did have a benefit. It extended the playing field to the upside, which I believe is a sign that we will see prices well above the $3.166 level again before the end of the year.

Going into the quiet period between October and December, I expect to see injections into storage slow down considerably because of recent evidence that producers are cutting output. Furthermore, we no longer have a storage problem which means there has been a draw down in supply. Now all we need is a blast of cold weather to ignite the next rally.

Unfortunately for short-term bullish traders, I think the market has to break further to give it buyers a chance a regroup at more favorable price levels. Barring any surprise in the supply/demand situation, I can’t see any compelling reason why a bullish hedge fund would want to chase the natural gas market higher at current price levels and without a cold weather forecast to back its position. Therefore, patience is called for by bullish traders. Just let the market work lower into a value area and let the big guys set the support then just wait for demand to pick up with the onset of winter.

The short side is tempting, but not a current price levels and not after the Thursday/Friday break. It is also a little more risky because in the near future the 90-day forecast will come out and if there is cold in the picture, you will get caught in a bear trap.