A Natural Gas Trade

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Temperatures are pushing 80 degrees here in Baltimore today. It sure seems like spring has sprung. I am openly praying that we do not get a repeat of last year's spring. It was cool and rainy until June. I swear I recall that temps didn't get above 80 until the week the pool was to open in June.

Last summer was pretty mild in general. So was this winter. As a result, natural gas inventories are very high. In fact, the Energy Information Agency (EIA) says that nat gas storage levels are 36% above the five-year average for this time of year.

And just like with oil, the oversupplied natural gas market means that prices are in the tank...

Natural gas prices are at 17-year lows. It's borderline disastrous for natural gas companies. The low prices are enough to have former natural gas corporate executives drive their cars into walls.

But here's the thing: when you see prices making such extreme lows, and sentiment basically assuming that the fundamentals will never get better, well, you should start looking for upside moves. I think natural gas is poised for higher prices...

Just look at what oil prices have done over the last month. In January, it was all doom and gloom. Supply was surging, the Saudis were pumping as much as they could, oil prices had fallen to $28 as global growth concerns were rising, and Goldman Sachs was saying that oil prices could fall to $20 a barrel or lower.

Today, oil prices are hitting $37. That's a 32% gain in just a few weeks. Why? I don't know, exactly. The agreement between Saudi Arabia and Russia to cap production is nice, but it doesn't really change anything. The oil market is still oversupplied by +1 million barrels a day.

Still, traders are following the supply and demand playbook. When prices drop, the formula says that demand should increase. And that's happening with oil. Americans are driving more, and the world is using more oil. We should anticipate a similar trajectory for natural gas.

It's Gonna be a Hot One

We've already seen demand for natural gas rise in response to low prices. The amount of electricity generated by natural gas, as nat gas plants replace coal plants, is surging. Electricity produced by coal is expected to fall 12% this year. And for the first time, more electricity will be generated by natural gas (33.4%) than coal (32%) this year.

Still, that growth in natural gas use is pretty easy to predict and account for. What we really need is a catalyst for higher nat gas demand that people don't see coming...

And I have one for you.

Before I go on, let me just say up front that I am not a meteorologist. I can barely name the different types of clouds, much less put together a forecast of how the Gulf Stream will affect temperatures and rainfall in Baltimore. So I am relying on the professionals here. And they are saying that weather trends this summer might favor a nice jump in natural gas demand — and price.

Let me share an excerpt from a recent Bloomberg article:

A number of El Nino-Southern Oscillation indicators suggest that the 2015-16 El Nino has peaked and weather models predict it will decline in coming months, Australia’s Bureau of Meteorology said on its website on Tuesday. Conditions will return to neutral during the second quarter with a chance of La Nina in the second half of 2016, it said.

La Nina is a cooling in the equatorial Pacific Ocean, sometimes thought of as El Nino’s opposite. The two are extreme phases of a naturally occurring cycle, according to the National Oceanic and Atmospheric Administration. Based on the 26 El Nino events since 1900, about 50 percent have been followed by a neutral year with 40 percent by La Nina, according to Australia’s weather bureau.

The current El Nino is rated as one of the three strongest since 1950. The warming of the equatorial Pacific changes weather worldwide, bringing drought to parts of Asia while the southern U.S. can get more rain.

La Nina can also roil agricultural markets as it changes weather. A large part of the agricultural U.S. tends to dry out during La Nina events, while parts of Australia and Indonesia can be wetter than normal. Citigroup Inc. has said that a transition to a strong La Nina may present significant upside potential for grains price volatility.

So, there's a good chance that we'll have a hot, dry summer here in the U.S. And that would create the perfect scenario for natural gas prices to surge higher in the coming months.

Sentiment Turns on a Dime

If you pay attention to how investor sentiment can shift, well, you know that it happens quickly. Just a month ago, the global economy was thought to be in a tailspin, and the U.S. economy was in recession. Today, the fear of U.S. recession has been pretty much stricken from the record, and stock prices have ramped.

A similar thing could easily happen to natural gas. I think it will. In fact, I think it's already started.

Here's a two-year chart of the U.S. Natural Gas Fund (NYSE: UNG)...

It's tough to find a more beaten down chart than this. But in just the past few days, buyers have been stepping in and volume has picked up noticeably...

It looks to me like natural gas is breaking out. And the move could push the UNG at least 25% higher. That would take it right to the 50-day moving average, represented by the blue line at $7.50.

I think buying some UNG is a pretty low-risk trade right now. And you could make some pretty good loot over the next couple of months.

Until next time,

Briton Ryle

@BritonRyle on Twitter

An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.