Outlook For Natural Gas

By Cynthia Kase, CMT, MFTA
President, Kase and Company, Inc. CTA

After a prolonged two year corrective phase, natural gas broke higher about six weeks ago, lagging crude’s bullish run by more than a year, and at this time, March 12, 2008, is roughly 10% of crude’s price. So the two pertinent questions are how high gas is expected to rise, and how to know when the run is over.

Introduction

First, some introductory remarks to those unfamiliar with natural gas. Natural gas is a seasonal commodity. Many in the market think of the year as having two seasons, winter from November to March and summer from April to October. April is considered a shoulder month for the summer, which means it’s usually a low demand month, but because this March has been colder than normal, April has been supported partly for that reason.

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April is currently the first nearby contract, with May becoming prompt on March 27. The average April/May spread has been about 1% or about five cents, and the contracts have a correlation of about 0.85 based on the R2. So, roughly what can be said about April applies to May as well.

Today, the spread is about negative six cents, at the 15th percentile historically, and should narrow and potentially go positive. The negative spread might also support the idea that some of the strength in gas is purely technical, influenced by spillover factors from petroleum. Some have puzzled about why natural gas, considered a North American market, has been influenced by global crude and value of the dollar. North America includes Canada, though, from which the US imports 15% of its gas, and the USD fell more than 50% relative to the CD, so this might finally be having some influence along with roughly 3% foreign LNG imports.

Finally, it’s not unusual for an energy price rise in the face of normal to high inventories for purely psychological reasons, such as fear of the future, or technical trend following. Such markets can continue to rise for what many would consider “no good reason” until inventories are so full as to trigger large sell offs. Currently US inventories are about average (10% below last year and 4% above a five-year average). These days, when the mindset is bullish, the focus is just on the year-to-year numbers which are positive right now.

In calendar April, “injection season” starts and regulated utilities begin to build inventories for next winter. Although some utilities may hedge or try to buy during dips, gas is injected more or less ratably over the summer. This means that physical natural gas will be purchased almost without regard to price for the next six or seven months. Despite regulators’ concern about price, it’s of even greater importance to have security of supply. Based on historical data, current inventories will have to rise to about 240% of current levels by November. Add to this fear about hurricanes and fertilizer demand, and you’ve got the ingredients for an unthinking run to much higher prices that could be sustained at least into the fall.

Technical Forecast

The April chart breaks down into two levels. The first has to do with waves that have starting points before the major corrective pennant, commencing with the $4.376 contract low. The second relates to waves after the pennant from $7.03.

NGJ08 Waves Up from Contract Low $4.376

Targets projected by, and common to both levels in the formation are examined. The most important target is $10.65, which is not only common to both levels but is the lowest price found by both. This is a “connector” between the most recent and the earlier price activity.

The last wave before the pennant is $6.98 - 9.222 (shown in red above) and the current $10.139 high was the 1.38 projection. Next in line is the 1.62 projection of $10.65, which is also the 1.62 corrective projection based on the down move $9.222 - 7.03 (in blue).

Kase arrays targets in a grid to see how they connect. The table below shows $10.65 connecting all waves up to $9.222 via the corrective projection noted above. Also, $10.65 connects to $14.9, as both are 1.62 projections of waves up to $9.222. Other significant patterns are an across-the-row connection with increasingly larger projections from $11.0 to $11.7 to $14.9 for the early wave $4.376 - 7.25. Also note the diagonal pattern between $11.7 and $14.9. So should $10.65 be overcome, there is a reasonable chance for at least another $1.00 jump and a continuation towards $15.0.

NGJ08 Wave Projections from $4.376

Unlike equities, natural gas, similar to many other commodities, usually forms regular nested three-wave or “abc” patterns. The waves up from $7.03 are shown below, with the abc labels and projections for waves.

NGJ08 Waves Up from $7.03

The first very small wave, $7.03 – 7.56 (in red) met its 1.62 projection at $7.945 then extended beyond that normal target to the corrective projection of the $7.56 – 7.05 leg (blue) of $8.312. So that was bullish. The larger wave from $7.03 to $8.312 met the 1.38 projection at $9.391, and 1.62 at $9.605. The normal wave targets have been exceeded, which is again bullish and calls for $11.0 and then $11.7 to be met. Without going into detail, the table shows connections between $11.0, $11.7 and $14.9 for these more recent waves.

NGJ08 Wave Projections from $7.03

The patterns up from $7.541 are more regular, with the first wave, (wave a of C) meeting its 1.62 target at the $10.139 high. Wave a of c of C met the 1.38, 1.62, and then 2*1.38 targets, showing the market’s bullish, extending nature. All the remaining waves project at least to $10.65, and connect to $11.7.

Prices should continue to rise and although stalls may take place, strong resistance isn’t expected until $11.7. Then, there could be a major test, but odds today would still favor a run towards $15.0 eventually.

With April having risen for six weeks straight, a correction might be expected, but there are virtually no negative signs, especially with today’s close above $10. The small down waves after $10.139 project to $9.50 and $9.27. A bullish pennant or a coil formed today. If it’s a coil, prices could fall to about $9.30 just above the $9.27 target, but odds favor a breakout in the direction of the prevailing upward trend and projects to $10.65.

Kase uses stops that are based on standard deviations of TrueRange to determine support. Daily stops that correspond to weekly are most important. The prices that correspond are $9.50 and $9.27. Similar values for the perpetual first nearby contract are $9.08 and $8.85. These prices give a clue as to what decline is allowable for a more major correction.

Next are retracements for the perpetual. Both $9.50 and $9.27 are confluent. But if prices were to drop to $9.08 or at the lowest, $8.85, the overall outlook would still call for a recovery following a deeper correction. This is because $8.85 is in the 21% retracement position for the entire bull run.

Summary

To summarize, today there are no signs of a market turn or that the bull run is over: Because prices have risen without interruption and have stalled around $10 for a few days, a correction could take place soon. If the market remains very bullish then $9.50 should hold, but a drop to about $9.27 could take place on a short-term fluctuation, triggered by a storage or weather report, and pose no damage to the overall tone.

Next key resistance is $10.65, above which prices could quickly rise about another dollar to $11.70, then a major test could take place, but odds would highly favor a price near $15.0 being attempted.

On a more serious, prolonged correction a decline to $8.85 is allowable based on the perpetual chart, and provided that holds, a recovery would still be called for. Again, at present there are no technical signs that a correction is imminent, and these levels are for guidance only, but a close below $8.85 for at least a couple of days would signal the run is probably stalled if not over.

Cynthia Kase, CMT, MFTA, president of Kase and Company, Inc., CTA is considered by many to be the energy market’s premier technical forecaster and advisor on trading and hedging issues. Educated as an engineer, she worked as a trader and risk manager for Chevron, Chemical Bank and the Saudi Oil Ministry’s consulting arm, Petronal, before launching Kase and Company, Inc. in 1992 (www.kaseco.com), which primarily focuses on providing trading and hedging strategies, software and solutions to the energy market, but also offers speculative trading indicators called StatWare (www.kasestatware.com) on a wide range of trading platforms including eSignal, NinjaTrader, CQG and Aspen Graphics. Ms. Kase is a Chartered Market Technician, winner of the MTA’s “Best of the Best” Award (1997) and is the first American to be awarded the prestigious MFTA diploma by the International Federation of Technical Analysts. She can be reached at kase@kaseco.com or (505) 237-1600.