I live on the West Coast, and the weather here is warm, unseasonably warm, in fact. Now, I admit that sometimes I like to rub in my good fortune to my friends, family and colleagues in the Midwest and on the East Coast.
Much as I am fond of jesting about the 80-degree sunny days here of late, the weather situation in much of the country is no laughing matter. In fact, Mother Nature has been downright cruel this year, with the "polar vortex" and sub-zero temperatures making life miserable for millions of Americans.
While there's not much anyone can do about the cold-hearted vixen's actions, traders could take some solace in making a few extra bucks trading one sector that benefits from this big chill -- natural gas.
Since November, the metrics in the natural gas space have been firmly in the bulls' favor. The chart of the United States Natural Gas Fund (UNG) shows the big spike higher in the commodity that began in early November and sent UNG well above both the 50-day and 200-day moving averages.
In Friday trade, UNG surged more than 8%, making a 52-week high, as natural gas futures broke to a three-and-a-half year high, topping $5 for the first time since 2010.
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Now, while UNG is a good way to play the positive supply/demand metrics fueling this commodity, it's not the only way to do so. In fact, in situations where commodity demand is high and supply is falling, I like to look at the opportunities in the companies engaged in the exploration and production of the underlying commodity. However, before we get into that, let's look at the supply/demand equation a bit further.
My friend and colleague, Tom Essaye, editor of The 7:00's Report, is my go-to expert on all things commodity related. Tom used to be the head of a commodities trading firm, and he knows more about what drives prices higher than anyone else I know.
According to Tom, "For the last several years, the only reason to be a 'bull' on natural gas was because you believe in surging demand. You admitted supply was surging at the same time, which it is, but, you were a bull because you thought demand would surge more. Well, thanks to the 'Polar Vortex' and a cold winter that isn't over yet, the 'given' of huge supply is starting to come into question."
Tom further explained that analysts are expecting a near 300 BCF draw on natural gas supplies this year, which would be a record and put inventories well below the five-year average. "If the winter stays cold, we could exit the winter heating season at or below that inventory level, and if we do, then not only is demand bullish for natural gas, but then so too would supply, as it would be at multi-year lows," said Tom.
As for how to trade this thesis, I like the First Trust ISE Revere Natural Gas Index (FCG), an ETF pegged to an index consisting of companies that derive a substantial portion of their revenues from the exploration and production of natural gas. In other words, you're buying the companies that benefit most from the bullish nat gas price thesis.
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The chart below shows the big move higher in FCG since June. It also shows the fund has been consolidating around its 50-day moving average from early November through mid-January.
This week, shares nearly hit a new 52-week high, but then pulled back on Friday. This is the buying opportunity I've been waiting for. Those who take advantage of this latest dip could be rewarded with a move of about 15% or more this winter.
Recommended Trade Setup:
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-- Buy FCG at the market price
-- Set stop-loss at $18.25, approximately 8% below recent prices
-- Set initial price target at $22.75 for a potential 15% gain in six weeks