Natural Gas: The Next Widow-Maker?

You’d have to live under a rock to not have heard about the U.S. shale gas boom. Yet, despite the lure, and true potential, of this newfound industry… many of the details are still being worked out.

The gas is there…. Check!

We can get the gas out… Check!

And we can even pipe the gas throughout much of the U.S… Check!

But we still have a long way to go before the natural gas supply chain is built out on a scale that rivals crude oil. The infrastructure simply isn’t there. We need more pipelines. More liquefied natural gas (LNG) port terminals and ocean liners. And if natural gas is ever going to be used for transportation in the U.S., hundreds of thousands of gas stations must be built or converted.

As the infrastructure build out works to catch up with the drillers, supply outstrips usable demand. And that keeps prices down. In 2005, natural gas futures traded well above $25. Yet since 2011 we haven’t seen natural gas above $5. Mostly it’s been under $4.

The tight, sideways channel between roughly $3 and $4 has no doubt frustrated natural gas traders for the past year. And I think this market has the potential to be a “widow-maker,” much as the short yen and Japanese governrnment bond trades were described from 2010 on.

What do I mean?

Well, most traders believed the yen had only one direction to go – down. Many loaded up on short trades, only to find out they were way too early. Tight stop losses, and a volatile, sideways trading range chopped up many trading accounts.

Natural gas has the potential to do much the same. It seems natural gas prices have just one way to go – up. And this will likely prove true, in the long-run. In the short-run, we could see sideways trading in a tight channel for many more months.

Here’s a chart of natural gas futures, with each candlestick representing a week’s worth of trading. I’ve labeled each rally that has attempted to break above $4. So far, all have failed.

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1) A bullish engulfing candle in early 2012 looked promising, but the $4 level quickly pushed prices back down.

2) The $4 level was pierced two weeks in July, but both times prices closed well under $4 by week’s end.

3) Last October we saw two weekly closes above $4. This likely suckered in many bulls. Yet a week later, we were back under $4.

4) The same three-week reversal patternrn as in #3 developed just a few weeks later. Again, $4 was rejected, sending price all the way to the bottom of the channel.

5) And currently, we’re seeing another attempt to take out $4… to be continued…

How will we know when a natural gas bull market has begun? Ideally we’ll see a strong break above $4, then a small pullback in prices that test the $4 level again. If $4 holds as support on the retest, I’ll have more confidence that this market has bottomed.

But for now, you’re best to stay on the sidelines until a clear trend develops. There are better ways to make coin off the natural gas boom. Rodney hinted at some above. And I have my eye on one midstream pipeline and gathering outfit that does very well regardless the price of natural gas. More soon.

Adam O’Dell

Using his perfect blend of technical and fundamental analysis, Adam uncovers investment opportunities that return the maximum profit with minimum risk.