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Hedgers Unmoved By Early Heat; July Weakens

July natural gas futures fell in active trading Monday as traders viewed the market as not having sufficient trending characteristics and others were unmoved by early heat. At the close July had fallen 11.1 cents to $4.646 and August had dropped 11.1 cents as well to $4.678. July crude oil tumbled $1.99 to $97.30/bbl.

Traders who utilize trend following methodologies haven't necessarily attempted to follow the market higher."We are right up against a trendline in the July contract so I would not have a buy signal until the July contract closes over the $4.655 area," said an Oklahoma City trader.

"At one point the market was over that level, but I would use a close-only price to make a market entry. At $4.81 I would have gotten a buy signal, but now that the market is back down below the trendline, I am still neutral. I have been neutral on the market during this recent advance. I am more of an intermediate term player so I don't follow these short term moves. $4.70 would give me a good buy signal," he said.

One set of traders that did not buy into the recent rally were end-users. "Some of my utility accounts actually lifted their call protection when the market got close to $5," said a California risk-manager. "They didn't believe that the early hot-weather was much to worry about. There was some air-conditioning demand and then nothing. My traders are all quiet," he said.

Other traders see little change in the supply-demand dynamics of the market, but they wouldn't be considered quiet. Some have covered their short put options and sold calls. "Fundamentally, we don't see the past two weeks rally as a game-changer (or a trend-changer) for the gas market. We still believe the gas market is establishing a major bottom and breaks into the high $3.00 will be well contained," said Mike DeVooght, president of DEVO Capital, a Colorado-based trading and risk management firm.

A few warm days will not be enough to push the gas market into a bull market, and much of the market's recent firmness is attributable to spread trading between natural gas and crude and petroleum products, he said. "We feel a considerable amount of [last] week's rally can be attributed to unwinding of the short gas-long complex Btu spreads. As it will be for many of the commodity markets, it is going to be difficult for the gas market to have a major sustainable rally in the face of weaker economic growth in the U.S. On a trade basis, we have covered our short puts and sold calls this past week."

For trading accounts DeVooght counsels holding short $4.70 July calls and for producers and those with exposure to lower prices he advises holding a July-October spread consisting of $4.50 put options offset by the sale of $5.50 call options at even money. He suggests increasing the hedge from 10% to 40% of market exposure. He also advises holding long November-March $4.75 put options offset by the sale of $7 calls for a 16-20 cent debit.

"We will continue to use rallies into the mid to high $4 level as a selling opportunity, primarily utilizing collars and selling call premium," he said. "If we break back under $4.15, we will book profits on the short calls and sell put premium. Not exciting, but the best way (in our opinion) to trade this market until we get a break of the range. We will continue to hold our current collars and will look to sell calls if we trade back above $4.60 or sell puts if we break below $4.15," he said in a weekend note to clients.

Last week when July was trading above $4.80, traders' perceptions were somewhat different, according to data from the Commodity Futures Trading Commission. In its Commitments of Traders Report showing what managed money did for the five trading days ended June 7, traders overwhelmingly added to long futures and options relative to increases in short positions. At the IntercontinentalExchange long futures and options (2,500 MMBtu per contract) rose by 65,916 to 496,790 and shorts increased by 3,528 to 40,326. At the New York Mercantile Exchange long futures and options (10,000 MMBtu per contract) rose 47,871 to 180,744 and short positions increased by 7,635 to 155,670. When adjusted for contract size, long positions at both exchanges rose by 64,349 and short contracts grew by just 8,517. For the five trading days ended June 7, July futures increased 16.5 cents to $4.831.

Near-term weather patterns favor the bulls. MDA EarthSat in its six- to 10-day outlook shows above- to much-above-normal temperatures south and east of a broad arc extending from southeastern New Mexico to northern Minnesota to Maine. The Great Basin and Rocky Mountains are forecast to be below normal.

"While the timing of the next surge of heat may be a little slower in the near term, it should be firmly in place by the start of this time frame," said MDA EarthSat. "The overall themes are a good match to expectations from late last week, in a pattern with increasing influences from a combination of -PNA [Pacific North American pattern] and +EPO [Eastern Pacific Oscillation] signals. With the trough West/ridge East pattern returning, temps from the Midwest to Mid-Atlantic should climb to much above normal for at least a few days. While details tend to vary a bit, most models are in decent agreement on the overall pattern evolution and the likelihood of more much above [normal temperatures]."

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