It’s hot out there…
Temperatures are breaking records in the Pacific Northwest. Now the northeast is going through a brutal heat wave as well – and summer has just started.
With extreme weather, comes extreme price action in natural gas. That’s because unexpected heat waves strain the power grid and cause prices to soar.
No other product is as sensitive to weather spikes as natural gas.
When commodity traders see hotter than expected temperatures take hold, they know that prices can jump quickly. The same holds true when temperatures drop more than expected, as we saw during the Polar Vortex of 2014.
Some investors may be looking at previous supply shocks as a framework for playing today’s movement in natural gas.
Although the way that short-term prices will evolve will probably look similar, the long-term dynamics affecting natural gas today are worlds apart to what it was previously.
A Roadmap for Playing This Heat Wave
At this point, natural gas is already up 22% for June. Judging from previous well-known weather shocks, we may be nearing a short-term top.
Take a look at this chart…
It shows how the previous two well-known weather-related supply shocks have affected the price of the US Natural Gas Fund (UNG). You can see that each event caused a peak in price no more than 40 days after the initial price shock. Prices then moved lower in the days after.
The movements should tell you three things…
Weather-related supply shocks are terrible indicators for long-term prices
Natural gas has only risen 20% from the current heat wave
Prices can rise as high as 30-50% within 35 days before falling
This kind of dynamic is the way most “hype lifecycles” in commodities play out when it comes to weather.
Notice how prices revert to where they started, or worse, within three months…
With most of the upside in natural gas already realized, we’re probably nearing the peak of this particular “heat wave cycle.”
But, this time around, the underlying supply and demand dynamics will make a pullback in natural gas a buying opportunity.
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Bullish on Natural Gas Dynamics
During these previous extreme weather events, producers were in a rush to pump for gas, but this time production has slowed.
Combine that with the already tight supplies due to the pandemic, and the natural gas market is bracing for even higher prices this coming winter.
Currently, two factors will create support from the inevitable pullback as the hype lifecycle plays its course. And one of them involves a growing sub-industry within the natural gas market:
Bigger seasonally adjusted supply drawdowns than normal (even without the heat wave)
Liquified natural gas (LNG) exports are becoming a long-term game changer
And it’s not just the U.S. market that’s benefiting from increased LNG use, it’s happening around the world.
The global LNG trade will rise by 21% by 2025, with the U.S. becoming the biggest exporter… and China is set to surpass Japan as the biggest importer of LNG this year.
In the past, LNG has been a globally segmented market, with no real effect on natural gas prices.
But now, it has become globally competitive… and with increased competition come higher prices.
A Better Way to Get in on Natural Gas
Choosing the best play for natural gas exposure can be tricky…
Products like UNG or the ProShares Ultra Bloomberg Natural Gas (BOIL) are terrible vehicles for long-term holds in portfolios. They’re good for short-term trading… which would work well right now.
For example, since this time last year, natural gas prices are up 152%. But these returns are an illusion for investors that use ETFs like UNG – having only returned 42% during the same stretch.
A better way to get long-term exposure is to invest directly into natural gas producers.
On average, natural gas producers have returned around 170% since last June, surpassing even headline natural gas returns.
Investors should use this heat wave to trim exposure of their gas producing stocks, and use the inevitable pullback once this heat wave is over to add or create new positions.
For short-term traders focused on taking advantage of price fluctuations from this heat wave, I expect UNG to trade around 10% higher in the short term, comparable to prior weather-related supply shocks, before finally capitulating down again.
Regards,
Eric Shamilov
Contributing Editor, Market Minute
Reader Mailbag
Will you be taking advantage of this movement due to the heat wave? What’s your plan to trade it?
Let us know your thoughts – and any questions you have – at feedback@jeffclarktrader.com.