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Directional Traders Piling on Short Side of Market; May Slides

May natural gas futures opened higher Monday but quickly tumbled nearly 20 cents to land solidly in the loss column, as falling oil markets were able to tug natural gas lower. At the close May was off by 6.6 cents to $4.138 and June had declined 7.4 cents to $4.190. May crude oil swan-dived $2.54 to $107.12/bbl.

For the moment volatility has returned to the natural gas market. "We came in higher Monday and traded up to $4.27 and then boom, we plunged down to $4.09. The last couple of days I was surprised we bounced back up. I was thinking we would break $4.02 and then it would be down to $3.85 [last week]," said a New York floor trader.

"It's been a bumpy ride. The other energy markets, crude and products are getting hit pretty hard, and I think traders are selling natural gas a bit as well," he said.

"Maybe this week I'm right and we take it down to $3.85 or it trades between $4 and $4.20 all week. We've been in this range before and unless we break out to the upside at the $4.30 level or back down below $4.02, last week's low, you might see a continuation of last week's trading range.

"Today natural gas was finally following some of the other markets. The other markets had been up, up and away and natural gas didn't follow [but Monday it did]," he said.

Crude oil, heating oil and RBOB gasoline futures all plunged a day after Saudi Arabian Oil Minister Ali al Naimi said the market is “oversupplied,” according to a Bloomberg report. In addition, China, the world's fastest-growing oil consumer, increased banks' reserve requirements to try to stem inflation, a sign that fuel demand growth may slow. The Dow Jones Industrial Average fell 140 points to 12,201.

The New York floor trader apparently is not alone in his outlook for lower prices. According to government figures, directional traders, those not concerned with offsetting a physical position, overwhelmingly favored the short side of the market in a recent report. The Commodity Futures Trading Commission (CFTC) in its weekly Commitments of Traders Report said that as of April 12 managed money liquidated long positions and added to short holdings in more than a 2:1 ratio.

The CFTC disclosed that at the IntercontinentalExchange long futures and options (2,500 MMBtu per contract) fell by 21,971 to 272,557 and short contracts increased by 18,609 to 67,031. At the New York Mercantile Exchange long futures and options (10,000 MMBtu per contract) skidded 5,199 contracts to 140,314 and short futures and options contracts rose by 22,515 to 235,430. When adjusted for contract size, long futures and options at both exchanges fell by 10,691 and short contracts rose by a stout 27,167. For the five trading days ended April 12, May futures dropped 13.3 cents to $4.098.

Other traders favor utilizing options to play the long side of the market. Mike DeVooght of DEVO Capital Management, a Colorado-based trading and risk management firm, suggests that trading accounts hold a position consisting of the sale of July $4.00 put options initiated a week ago. The options were sold for 12 to 14 cents and it was recommended for no more than a 30% position.

End-users are also counseled to hold a similar position for 30% of their physical requirements, and producers should continue to hold a May-October strip consisting of long the $4.50 put offset with the sale of $5.50 calls at even money for a 10% position.

In spite of his bias to the long side of the market, DeVooght said, "There continues to be a lack of bullish fundamental news for the gas market. Production is more than adequate, [and] demand is flat because of relatively slow economic growth in the U.S."

DeVooght also notes that a "huge negative for the gas market is [a] lack of urgency by end-users to lock in forward prices." It's his observation that end-users feel they can wait and buy it cheaper on the spot market than pricing it forward. "What market force will eventually change this market psychology is yet to be determined," he said in a weekend note to clients.

That market force may be an improving inventory balance for the bulls. Peter Beutel of Cameron Hanover said, "Last week's [inventory] report showed stocks are now 137 Bcf and 7.86% lower than a year ago compared to 12 Bcf and 0.74% lower two weeks ago. Against the five-year average, they are 10 Bcf (0.63%) higher than a year ago, compared to 68 Bcf (4.37%) higher two weeks ago. Even though the heating season and the withdrawal part of the year are behind us now, underground storage levels have been improving steadily against last year's and the five years before this year."

The inventory dynamic combined with the technical outlook makes for an even more bullish scenario, in his view. "When one adds in a changing trend on the charts, or at least charts that appear to be showing a long rounded bottom, the improving inventory picture seems much more bullish than it was."

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