Natural gas prices may have finally bottomed based on their technical outlook. As you are probably all too well aware, after following oil prices higher into July 2008, natural gas prices have experienced a two-year decline due to supplies exceeding demand.
Henry Groppe, the highly-experienced oil and gas guru with Groppe Long & Little, believes that natural gas prices are headed higher later this summer – to above US$8 per million BTUs – on the basis that shale gas deposits are unlikely to add significantly to North America’s depleting natural gas reserves, and steep reductions in exploration and development tilting supply-and-demand towards a state of equilibrium.
Based on a review of the United States Natural Gas Fund (UNG-NYSE, $7.66), an ETF that tracks NYMEX prices for natural gas, the units of that ETF recently appeared to have broken out from a downward price channel (see chart below).
If the prices of UNG ETF units fail to find support along the top trend line in the chart above (at about $7.25 to $7.50) then the recent price activity will turn out to be a false break out. The Bollinger Bands shown on the chart above have pinched, which usually foreshadows that either an abrupt upward or downward move is about to occur.
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On the short-term price chart, UNG ETF unit prices appear to have formed a bottom at $6.75 with resistance at $7.75 despite what appears to have been a break out to $8.75 (see chart below). Should the $6.75 support level fail to hold then the downward price trend is still in tact, and if the $7.75 resistance level is penetrated then a significant price reversal may occur. Although the On Balance Volume (technical indicator where volume increases precede price changes) is starting to improve, the RSI (a momentum oscillator that measures the relative strength of the price of a security or, in this case, a commodity against itself) and MACD (a momentum oscillator that measures price divergence of moving averages to determine if a trend is about to slow or reverse) are both weak but improving. In any event, a test of the $6.75 support level over the next few weeks is a strong possibility.
Many sophisticated traders have found themselves on the wrong side of a natural gas trade, so it is too early to conclude that prices have bottomed. Perhaps the return of natty traders from their summer vacations will be the catalyst for higher prices in the months ahead.
Conclusion: Watch to see whether UNG ETF’s unit prices hold the $6.75 support level and manage to penetrate the $7.75 resistance level. A move above $8.75 – the height of the June price advance – would be bullish and may precede a more significant price move in the fall.
USO Rising Wedge
Subsequent to my previous article at Oil and Gas Investments Bulletin on oil prices, a reader asked how can we be sure the recent price action for the United States Oil Fund, LP (USO-NYSE, US$35.39), an ETF that tracks the performance of light crude oil prices, is a rising wedge. In response to that question, I offer the following comments.
With technical analysis you can never be sure, but wedges tend to have low failure rates in predicting future price action (i.e. prices may re-enter a rising wedge formation and move higher after finding support). Wedges require the convergence of two parallel lines with at least 5 reversal points (i.e. at least 3 on 1 trend line and 2 on the other trend line), declining volume during the formation of the wedge (i.e. a weak rally against the longer term trend), and confirmation of the breakout. In the case of USO (see chart from previous article below), we have 4 touches along the top trend line and 3 (almost 5) along the bottom trend line, volume decreased slightly during the formation, and the breakout was confirmed defined as a 10% move below the lower trend line (i.e. the weekly close of about $32 after breaching the lower trend line around the $36 mark for a move of 11%). The breakout is further confirmed by the RSI trend line breach. The price move towards the bottom trend line is typical price action after a downward breakout and generally precedes a more significant price decrease.
Wedges are variations of price channels, and a downward breach of a either a channel or wedge formation is bearish and can lead to lower prices until support is found. With technical analysis there is no certainty, but you are playing the odds or at least increasing your awareness of bearish indicators that could lead to lower prices or alternatively bullish indicators that could lead to higher prices. In any event, watch support levels for breaches. With USO, a breach of $30 could result in prices retesting the February 2009 lows, which could provide an opportune re-entry point should that price action occur.
Brian Hoffman, CA, CPA, is an affiliate of the Market Technicians Assoc. and a member of the Canadian Society of Technical Analysts (E-mail: bk.hoffman@rogers.com)
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