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By: Costas Bocelli — January 12, 2011

Has Natural Gas Finally Bottomed?

THE COMMODITIES SECTOR WAS ONE OF THE TOP PERFORMING ASSET CLASSES IN 2010, WITH PRICES SOARING ACROSS THE BOARD.

Precious metals were up big ... 

Base metals, like copper, made record highs ... 

Tight supplies and bad weather sent corn, soybeans, and wheat to the moon ... 

Even soft commodities like sugar, coffee, and cotton made stellar gains.

The Thomson-Reuters/ Jefferies CRB Commodity Index was up 18% for 2010.  Since the market rally in September, the index has gained 29% in 4 short months. 

Yes, the Commodity sector was in a bullish feeding frenzy, except for ... Natural Gas.

Natural Gas prices have been in a dismal decline since the commodity bubble burst in mid 2008, just before the credit crisis sent the world into the great recession.

2010 was another difficult year for Natural Gas, and it was unable to ride the commodity rally with the rest of the sector.  Natural Gas prices fell 35% last year, making it -- by far -- the worst performer in the space.

Although energy is in high demand in the United States and abroad, Natural Gas supply has been abundant and plentiful, putting pressure on prices.  New technologies and large discoveries of proven reserves have been the main driver of lower prices.

Have a look at the Natural Gas February Futures Contract (weekly) ...

(Click on image to enlarge)

 
You can see that it maintained a bearish trend throughout the year, making a series of lower highs and lower lows in a downward channel.

But now, the early price action this month appears to exhibit a technical breakout from the pattern.  Is this the start of a turn in Natural Gas prices, and an indicator that a floor has been put in?

Is it Finally Time to Get Bullish?

Some very smart investors think so.  Hedge funds almost doubled their bullish bets that Natural Gas prices go higher -- in fact, their net long positions have increased by more than 90% since the end of 2010.  According to the Commodity Futures Trading Commission (CFTC), which tracks these large positions and open interest, the surge was the largest increase in over a year.

It's hard to say what their time frame is on the bullish play.  But with Natural Gas prices at historic lows, inventory levels not breaching 2009 record levels, and harsh winter snow storms hitting major cities in the United States, the bet makes perfect sense.

Longer term, Natural Gas may play a more significant role in how we deal with energy consumption.  As oil prices rise, alternative resources attract greater attention.  Green energy innovations such as solar and wind are still in their early stages and a small piece of the pie to a real solution.  However, Natural Gas continues to grab share from Coal when it comes to electricity generation.

Chesapeake Energy (ticker: CHK) is the second largest producer of natural gas and one of the most active drillers of new wells in the U.S.  They have a vast amount of proven reserves.

Their biggest shareholder, Billionaire Carl Icahn, recently doubled his equity exposure in CHK.  According to an SEC filing that was released in mid December, he now controls almost 6% of the company, or 39 million shares.  Obviously, Mr. Icahn thinks that the current valuation of Natural Gas is quite compelling.

The stock is up 17% since the Icahn news became public.  CHK is a pure play on where Natural Gas prices are headed.  Aside from their production, the company has a very large proprietary trading desk that makes them the ultimate player in Natural Gas prices.

Here's a daily Chart on CHK ...

(Click on image to enlarge)
 
 

Another way to play Natural Gas is through a very liquid and heavily traded ETF.  The United States Natural Gas Fund (ticker: UNG) seeks to replicate the performance of Natural Gas Futures prices on the NYMEX.

Because of the contango effect on Natural Gas Futures, there has been some price slippage as the fund rolls over their expiring contracts.  Recently, with the price of Natural Gas bottoming, some of the contango effect has lessened, which reduces the slippage.  The shift in skew (contango) across contract months also indicates a bullish bias in prices, as there is more interest in near term delivery.

Here's a daily chart on UNG ...

(Click on image to enlarge)

 
Very similar to the Natural Gas Futures contract, UNG appears to have bottomed, and is making a bullish uptrend, putting in higher lows (green line).  The longer dated downtrend line (red line) was also breached.  If UNG trades higher, the 200-day moving average could be the next resistance level, or 10% higher from Wednesday's close of 6.14.

Could 2011 be the year for Natural Gas?  We shale see ...

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