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Traders Question Viability of Recent Advance; June Inches Lower

June natural gas futures showed little movement as traders see a market driven by short-covering by funds and managed accounts rather than any fundamental development that could provide a sustainable base for further gains. By the end of the day June had eased half of a penny to $4.693 and July had risen two-tenths of a penny to $4.763. June crude oil dropped 41 cents to $113.52/bbl.

"I didn't see any reason for the rise last week other than traders couldn't get it below $4 and a failed sell-off [rising prices] followed. The bullish storage number was maybe enough to push out the weak shorts, but I don't know if there was anything fundamental that was able to push prices to this level," said a New York floor trader.

"I think it was short-covering that took us to where we are now, and I think people are looking for a place to sell the market, but some of the shorts are getting hurt in the process [as prices rise]."

He suggested that further gains might inspire additional short-covering. "From $4.78 to $4.82, if the market gets that high, it will generate bullish sentiment from a technical point. The market could start to build a base there. However, if it fails against that area, traders will likely sell it down from there. The market hasn't proven that it can hold above it so I can't say that it is a 'buy' now," the floor trader said.

The trader's assertion that short-covering brought the market to where it is now falls in line with recent figures from the Commodity Futures Trading Commission. In its weekly Commitments of Traders Report directional traders covered short positions at a rate nearly five times greater than they entered into long positions. For the five trading days ended April 26 at the IntercontinentalExchange long futures and options (2,500 MMBtu per contract) rose by 40,509 to 352,043 and short contracts increased by 4,478 to 51,725. At the New York Mercantile Exchange long futures and options (10,000 MMBtu per contract) fell by 5,461 to 136,681, but short contracts tumbled by 23,926 to 207,348.

When adjusted for contract size long futures and options at both exchanges rose by 4,666 but short futures and options dropped by 22,807. For the five trading days ended April 26, June futures rose 13.4 cents to $4.444.

Short-covering or not, top traders are starting to adjust their strategy as the market reaches the top end of its long-standing trading range. Mike DeVooght of DEVO Capital, a Colorado-based trading and risk management firm, believes that "the gas market is bottoming out and will be working higher in the weeks and months to come." However, with what is seen as a "large amount of gas that many believe can come to market, the gas market will gradually advance, not rally as we have seen in the past," he said.

"Considering the large short speculative position, there is always the possibility of a sharp upward spike if a few of the major shorts were to head for the door. On a trade basis, we will continue to trade the range. We [will] sell calls and do some short-term hedging when we are on the top side of the range, $4.60-plus, and sell puts and cover short hedges when we approach the $4.00 level. We will continue to utilize this strategy until we get a significant break of the range," he said in a weekend note to clients.

For trading accounts as well as end-users DeVooght suggests selling June $4.80 calls if June trades at that level. For producers and those with exposure to lower prices he recommends holding on to a May-October strip consisting of $4.50 put options offset by the sale of $5.50 calls at even money for 10% of market exposure.

Technical traders see the market at a key threshold and poised to move decisively higher. "Since natgas held our key support back at the $3.731 low, $4.635-4.710 has been our pivotal resistance," said Walter Zimmermann in a weekend note to clients. "Last week's target was $4.635 and last week rallied to a $4.622 high. The natgas bears are in big trouble if this $4.635-4.740 zone is decisively exceeded. In that case our minimum target becomes the $5.400-5.500 area."

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