Friday's Report #6
Here's an explanation of what contango is, if you already know what this is, skip down to the charts!
Contango: The New Four-Letter Word
Contrary to what some investor believe, UNG does not own pipelines and storage facilities filled with natural gas. The underlying holdings consist not of the physical commodity, but of futures contracts. As such, the returns to the fund are impacted by three factors: 1) changes in the spot price of natural gas, 2) interest income on uninvested cash, and 3) the “roll yield” (in order to avoid taking delivery of natural gas, UNG “rolls” its holdings each month, selling near-month contracts and buying up second month contracts). In 2009, almost all of UNG’s return was attributable to the third of these factors.
Natural gas prices went on a wild ride in 2009, but finished up about where they started. The same couldn’t be said for UNG. After closely tracking changes in the price of the near-month NYMEX futures contracts for much of the year, steep contango in futures markets hammered the fund in the year’s final four months when gas prices finally began to recover.Natural gas prices rose, but the recovery was roughly in line with the market’s expectations. The monthly roll became a costly endeavor for UNG, and the fund’s returns began to lag far behind a hypothetical return on natural gas. For all of 2009, UNG lost more than half of its value despite the fact that spot natural gas prices finished the year less than 1% below where it started.
The big gap between a hypothetical return on natural gas and the natural gas ETF led some investors to bash UNG as a flawed product. It’s not–the fund does exactly what it says it will do–but many don’t fully grasp the nuances of futures-based investing strategies.
2010: Freefall Continues
UNG’s performance in 2009 led some investors to look elsewhere for natural gas exposure , and inflows to the fund have slowed significantly; through the first two months of 2009, UNG saw cash outflowsof about $400 million. The fund’s performance, however, has been similar to last year, as the freefall in share price has continued through the first two and a half months of 2010. The fund is down about 20% on the year and has hit new lows on multiple occasions (most recently following Thursday’s EIA inventory data release). With memories of 2009’s dreadful performance still fresh, many investors have assumed that contango is once again the culprit. While the result may be the same, however, the main driver of the negative performance so far in 2010 is more fundamental in nature.
While it’s true that contango has eaten into returns a bit this year as well, the main driver behind UNG’s slide has been more fundamental in nature. The futures curve for NYMEX natural gas contracts is still upward-sloping, but the grade is moderate (May contracts were recently trading at about a 1.5% premium to April futures). This creates the potential for some adverse “roll yield” returns in UNG, but obviously doesn’t explain the 20% loss year-to-date.
UNG has actually moved in lock-step with natural gas prices so far this year, as the majority of the fund’s returns have been attributable to changes in the spot price of natural gas.
The causes for continued declines in natural gas prices are numerous; warmer-than-usual weather, weak demand from factories and manufacturers, and expectations for significant increases in supply in coming years have all weighed on prices this year. It has been these fundamental factors, not the slope of the futures curve (or “tracking error”) that have accounted for UNG’s decline this year.
It’s worth noting that UNG started out 2009 much like it has started 2010–moving downward in unison with spot prices. The major disconnect last year didn’t arise until natural gas prices finally bottomed out and headed higher, so the correlation may drop when/if prices recover.
TECHNICALS
What a week for natural gas. It could not rally at all. Well MMs knew that $4.50 would be a level that everybody would be buying so they took it down a notch. Now in-order for natural gas to be confirmed bullish for a 1-2 week bullish trade play, we have to rally above $4.50. IF WE DO NOT RALLY, NATURAL GAS WILL CRASH. WARNING. NATURAL GAS WILL CRASH IF WE DO NOT RALLY ABOVE $4.50.
Natural gas market participant can always count on: volatility. Indeed, natural gas volatility, both realized and implied, is consistently among the highest of all exchange-traded commodities. Not only is natural gas extremely volatile in its absolute price structure, its seasonal demand and storage cycles produce highly volatile intermonth spreads: In the last 30 months, natural gas prices have ranged from $11.80 to $2.50.
Daily Chart:
The daily chart is showing that the downtrend is losing steam. The RSI is 30 which means the futures contracts are oversold. Normally you want to be postioned bullish incase their is a bounce to the $4.82-$4.90 area of which you want to get rid of your long positions.
The weekly chart shows a different picture. Their are huge sell signals everywhere, so realize that if you are going long it is solely for a quick trade. I highly suggest everyone to trade UNG and not HNU.TO. UNG is a lot less volatile and you can sell calls against your position. In fact if natural gas closes flat for the week, I will of made a 2% return from selling calls even though my position is currently down 3%.
Weekly Chart:
Notice the TRIX & MACD bearish 'crossover'. Longer term you want to short UNG / buy HND.TO. If $4.50 does not hold, you will see a lot more bearishness to come. Play the game of probability !!!
COT #s
(if you do not understand what these mean, please refer back to report #4)
(if you do not understand what these mean, please refer back to report #4)
The first report shows the latest #s for ice contracts. Well what is a ICE contract you must be asking yourself. Here's a definition.
ICE’s standard OTC natural gas contract is denoted as “NG Fin, FP for LD1,” or Natural Gas Financial, Fixed Price for Last One Day (Futures Settlement), and trades in single lots of 2,500 MMBtus, one-fourth the size of a standard 10,000 MMBtu futures contract. However, an ICE natural gas lot is unique and trades in “flowper-day,” which mirrors the fundamental cash market. Since it is worth $75.00 a tick (30 days * 2,500 MMBtus/Day * $0.001),an ICE contract also offers considerably more return potential per contract than many other contracts.
How do ICE Natural gas contracts settle? ICE Natural gas contracts settle precisely to the futures expiration
price each month. For example, a Henry Hub swap buyer of the November contract will pay the fixed price (FP) and receive the last day settlement price (LD1) as published by the exchange on the 3rd last business day of the preceding month of delivery. The total profit or loss of the swap transaction is financially settled by calculating the difference between the FP and the LD1 price then multiplying by the total MMBtus (Lots * 2,500).
How do traders make money off of all of this? Do a basis swap.
A basis trader who sees low seasonal storage levels in a given market, or who believes weatherrelated
demand may increase regional prices, might want to buy the basis swap (pay LD1 and receive Index Price). The opposite trade would apply for traders who believe local market pricesare destined to fall relative to Henry Hub; they would want to sell the basis.
Here are both the ICE report (SPOT PRICE TRADING) and NYMEX report (LD1 Settlement Price)
ICE’s standard OTC natural gas contract is denoted as “NG Fin, FP for LD1,” or Natural Gas Financial, Fixed Price for Last One Day (Futures Settlement), and trades in single lots of 2,500 MMBtus, one-fourth the size of a standard 10,000 MMBtu futures contract. However, an ICE natural gas lot is unique and trades in “flowper-day,” which mirrors the fundamental cash market. Since it is worth $75.00 a tick (30 days * 2,500 MMBtus/Day * $0.001),an ICE contract also offers considerably more return potential per contract than many other contracts.
How do ICE Natural gas contracts settle? ICE Natural gas contracts settle precisely to the futures expiration
price each month. For example, a Henry Hub swap buyer of the November contract will pay the fixed price (FP) and receive the last day settlement price (LD1) as published by the exchange on the 3rd last business day of the preceding month of delivery. The total profit or loss of the swap transaction is financially settled by calculating the difference between the FP and the LD1 price then multiplying by the total MMBtus (Lots * 2,500).
How do traders make money off of all of this? Do a basis swap.
A basis trader who sees low seasonal storage levels in a given market, or who believes weatherrelated
demand may increase regional prices, might want to buy the basis swap (pay LD1 and receive Index Price). The opposite trade would apply for traders who believe local market pricesare destined to fall relative to Henry Hub; they would want to sell the basis.
Here are both the ICE report (SPOT PRICE TRADING) and NYMEX report (LD1 Settlement Price)
There is not a significant change in hands.
Over the short-run (1 week) , swap dealers (smart money) is bearish; but over the long-haul of this month (until March 26th, 2010) they are bullish since they hold aprils futures contracts. It would be an overstatement to come to any reasonable conclusion
One interesting note is that managed money which is also considered 'mutual fund money or dumb money'.. they are short the April contracts. This 'money' is usually wrong; therefore by March 26th (exp. of April contracts) I would expect Natural gas to be much higher than it is right now since theoretically they are not the smartest type of money :S
