After failing to break through resistance at $5.200 for a fourth consecutive trading session, the July natural gas futures contract dropped 16.5 cents on Friday to close just below $5 at $4.997 as traders took some profits off the table ahead of the weekend. However, the front-month contract increased by 21.6 cents over the previous week’s finish.

The week saw lots of back-and-forth trading as heat, supplies and storms were debated while rumors swirled about a Texas-based hedge fund that might be in line to become the next Amaranth after a number of wrong-way natural gas trades.

“I think what we’ve seen over the last few days is the market’s failure to push above this week’s new four-month highs, which seemed to trigger some weekend profit-taking,” said Gene McGillian, an analyst with Tradition Energy. “Right now, futures appear to be attracted to the $5 level and to cross through resistance near $5.200 we’ll likely have to see some pretty good verification that the hot weather is going to stick around into next month, or some tropical activity that has the chance to amount to something.”

Despite the pullback, McGillian noted that the market’s gains have been pretty impressive. “The market has made significant gains this month, but it might have gotten a bit ahead of itself. I think we deleveraged some of the speculative short positions that have been in the market for a while,” said McGillian. “The question now is once we’ve started to alleviate that pressure, are the fundamentals actually strong enough to continue this rally? With more than 2.5 Tcf of gas in storage, which is a reference-week record for the eighth consecutive week, we probably need to see a verification that industrial gas demand is increasing the way it looks to be and some sustained hot temperatures or tropical activity to really push the market up to another level of this rally.”

Traders and analysts alike late in the week were digesting reports that the $1 billion hedge fund SandRidge Capital is down 15% in the first two weeks of June on wrong-way natural gas trades. As reported by Reuters, the fund was caught out when the March-April 2011 spread surged 75%, leading some observers to draw similarities to Amaranth’s downfall, which occurred four years ago. Observers believe the fund was short during the recent rally.

“Spread trading can be dangerous. The spreads made some pretty sizeable moves and if you got caught on the wrong side, you got hurt,” said McGillian. “It is pretty much as simple as that. If you place the wrong bet, the market tells you you’re wrong, and if you have enough size in your position, it can be very costly. This is why natural gas is probably one of, if not the most, dangerous commodities in futures.”

McGillian said he doesn’t think the fund’s misstep resulted in the recent move to higher prices. “I think this rally we’ve seen this month is probably more precipitated on the fact that the market was heavily short, and the appearance of early hot weather that boosted cooling needs here in early June, put a lot of pressure on these shorts that basically rode the market down below $4,” he told NGI. “The new length in the market is not safe either. If we get some moderation in the temperature forecasts, the support for rising prices disappears and the new length in the market will get shaken too.”

Thursday’s reported gas storage injection of 87 Bcf, although generally in line with market expectations, was still way below last year’s 113 Bcf build during the corresponding period. Analysts see that dynamic continuing along with tropical storm uncertainty as maintaining a firm tone to the market.

Jim Ritterbusch of Ritterbusch and Associates sees “a significant downshift in storage injections through the first half of July…and the price up-spike of the past week is essentially discounting these assumptions. Shorter term, storage ideas will also be affected by the ongoing warm-up and we still feel that achievement of a 2.7 Tcf supply level per official month-end EIA [Energy Information Administration] guidance could prove out of reach. And although the market may have pumped an excessive amount of storm risk premium into the late-summer futures contracts, this insurance could be maintained into next month until a clearer look at the hurricane season is forthcoming.

“We are maintaining a near-term bullish view in anticipation of additional price gains capable of carrying July futures up into the $5.20-5.25 zone within the next two to three sessions,” he said Friday morning.

According to technical traders, spot natural gas futures would have to close below $4.600 in order to negate the bullish case. Brian LaRose of United-ICAP said the bullish case has the market in “an ABC advance up from $3.855. An immediate break to new highs would confirm this is [the correct] count. Our target in this case is $5.533-5.617-5.619-5.658. Fail to break above $5.230 and a period of consolidation before any new highs would be likely in the less bullish model. Only a decisive close below $4.591 can void these two bullish scenarios.”

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