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Broker: Fund Positions Indicate Upside Futures Trend Hasn't Ended

Urging market participants to move beyond the traditional risk management tools when trading natural gas futures, Tom Saal, of Commercial Brokerage Corp., said Wednesday that it is important to develop new techniques for identifying price trends and market timing. One pretty good way of identifying a "buy" signal recently has been simply observing how short the funds, or noncommercial traders, are.

Speaking at Natural Gas Intelligence's two-day natural gas futures workshop held at the New York Mercantile Exchange, Saal said, "When the funds get short 20,000 to 40,000 contracts, buy it." He said that over the past few years, when the funds have held significant net short positions, natural gas spot prices have usually headed higher.

As examples, Saal pointed to January and May of 2005 when noncommercial traders reached peak net short positions of 55,490 contracts and 45,334 contracts, respectively. Prompt month futures prices in both instances began to climb as noncommercials began to cover their shorts.

Following the significant short position in late January, prompt month futures reached a high of $7.850 on April 4. Likewise, following a similar net short position in late May, prompt month futures began climbing higher, reaching $7.800 on June 20.

The latest futures price increases might not be over yet. Funds and managed accounts represent a potential reservoir of further buying inasmuch as they are still holders of a significant number of short futures contracts. The Commodity Futures Trading Commission (CFTC) reported on June 17 in its Commitment of Traders (COT) report that as of June 14, noncommercials were net short 31,753 (futures only) contracts. This is only a minuscule decrease from the 32,957 contracts held the previous week.

In looking at price prediction, Saal said there could be a little more room to the upside as speculative traders could be motivated buyers. The COT data released Friday, which included market activity through June 21, revealed that noncommercials were still net short by 28,911 contracts.

Joining Saal at the NGI workshop was Sandy Trot, a Nymex local trader for 24 years and president of EnergyLinks Futures LLC. "Right now, the thing you have to be leery of is the fact that the funds were big time short," Trot said. "If they go long 40,000 to 55,000, that could take the prompt month up $1.00 in a heartbeat."

Telling workshop participants about trading last week, Trot said, "I was looking to pick a fight Thursday morning in the pit. The area was $7.62 to $7.66. I was buying and wanted to see how strong people felt about that level." After reaching $7.64, the July contract immediately fell lower Thursday, notching its $7.39 low for the day.

"Whenever you hear noise, noise, noise, and then it gets quiet in the pit, you want to fade the trend," Trot said. "All of a sudden this morning, there was quiet. Everyone was short. You don't want to bid it up, but crude oil had rallied 75 cents at that point.

"As of right now, the bulls and bears are split almost right down the middle. Right now it is a tug of war," the local trader said. "So there is choppy back and forth trading. I don't think we are ready for a big move up yet. I think it will wait until we get either extreme heat or the hurricane season starts up for real.

"I'm personally short July against the winter months for bidweek [this] week." Trot noted he is usually bearish from June 1 to July 20, which has historically been a period of lower prices. However, the local trader noted that from July 20 through Labor Day, he is normally bullish.

Talking about futures in general, Trot said the key spread is the one that bridges the winter strip to the summer strip. "March/April is the best spread out there," said Trot, who recommends buying the spread when it narrows and selling it when it widens. Buying the spread, Trot explained, entails the simultaneous purchase of the March futures contract and the sale of the April futures contract.

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