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Commercials Have a Lot to Learn from Speculators

Commercials Have a Lot to Learn from Speculators

Even the most seasoned commercial gas futures trader is no match for the speculator these days. These little known futures players with no physical presence in the market have shown a real knack for triggering major market moves and making big profits. They have a great track record of buying futures at the market lows and selling at the highs, while the commercial traders historically have stumbled into their buys near the top of price increases and mistakenly sold near the bottoms - "exactly the opposite way to trade if you want to make any money," noted Susannah Hardesty of Energy Research and Trading Inc.

Clearly there's something to be gained from examining the behavior of the speculators and attempting to use their ever-growing presence in the futures market to your advantage, according to Hardesty and Tom Saal of Pioneer Futures, two panelists at GasMart/Power '99 in Dallas, TX.

"What do they do to you. I've heard that they create volatility, that they move the prices away from where they ought to be fundamentally, and they also do this:...they suck money out of your wallet and put it in theirs," said Saal.

The market currently is chock full of them. As of May 4, according to the Commitment of Traders report by the Commodity Futures Trading Commission, the non-commercials, the speculative funds, held 15.7% of the total long positions in the market, or a net long of about 48,029 contracts, which is only about 2.3 percentage points off their record peak. Their long positions have ranged from a minimum of 2-3% to a maximum of 16-18% of total open interest historically. "And when they peak out and are starting to sell or close out of their long positions, generally speaking, almost every time the market is at its top," said Hardesty.

Where they go from here will play a large roll in where futures prices end up, but the jury is still out on the June contract. The funds could roll their positions into July, Saal noted.

"They are very aggressive, dynamic traders and they really make lots of profits in the natural gas market," said Hardesty. "They can sometimes even control natural gas prices much to the chagrin of industry users when fundamentals and the weather situation tells us that prices ought to be going down and you look and they're skyrocketing instead as they did in the late summer of 1997."

The market has been on a bull run for several weeks now, but commercials foolishly have been on the wrong side to profit. "[Commercials] had their maximum long positions at the bottom of the market in January and February... Remember when prices got to $2.10-$2.15 in March, there were so many commercials that started to hedge and sell at that point because we were up so much higher than we had been at the $1.65 level that they thought this was great. But that was just the first peak of my spring high. It was just a trigger point. If $2.10 or $2.15 was a good price to sell, [then] $2.30, $2.40 would be even a better price to sell. What are they doing?"

Hardesty said one thing speculators are very good at is identifying the breakout of a sideways trading pattern, like the one the market went through in December, January and February. "When the market enters a long, choppy sideways "congestion phase," in which prices remain within a 20-cent trading range for an extended period (35 trading days or more)., spec funds stay on the sideline and wait for an opportunity to jump in when prices move up."

Historically, when futures have moved in lengthy sideways congestion phases they have broken out and increased at least 45%, she said, sometimes even as much as 164%. "It's like you build this huge vacuum and nothing is being done and suddenly prices start to move, you get the spec fund activity in there, you get commercials starting to buy at a later point, but it creates a tremendous up-move coming out of these congestion phases. Spec funds know it, and they profit from it."

Despite the growing presence of speculators in the market, Hardesty said they have not significantly altered the historic cyclical patterns she has identified in the market. "I have identified in natural gas futures prices four major seasonal moves.[that have been present] since the beginning of [gas] futures trading." These include a winter low, a spring high, a summer low and a fall high. Hardesty said currently the market is near the second peak of the spring high, which she predicts will come in between $2.40 and $2.51/MMBtu. "Now should spec funds come in at the expiration of this current June contract and really come in with a burst of strength and cause a squeeze on the short positions of the commercials, spec funds have the capability of driving that high as high as $2.90. I don't know if it's going to occur, but I made sure all my clients are long.. We're totally positioned to take advantage of it whether it peaks at $2.40 or continues higher into the expiration of this contract."

She also expects a final peak of the spring high with a price range from $2.40 to $2.60, but she said spec funds could take it up to $3. The timeframe for the final peak is from June 7 to June 25. For the summer low, Hardesty sees prices reaching a downside target of $1.80 before rebounding on a strong hurricane season early next fall to between $2.50 to $2.85. She expects the final peak of the fall high to be anywhere from $2.80 to $3.40, but with spec fund participation similar to what occurred in the winters of 1995, 1996 and 1997 "we could have highs in the [near-month] futures contract anywhere from $4 to $5. This is the influence that spec funds can have."

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