Natural Gas Fundamental Analysis, April 11, 2017

Natural gas futures are trading slightly better early Tuesday as the pullback from 2 ½-month highs continued on Monday. The catalyst behind the price action was the return of mild weather that may limit demand and put a lid on higher prices.

May Natural Gas futures ended the session at $3.238, down $0.023 or -0.71%. The futures contract has closed lower five out of the last seven sessions. It is also down 2.8% since April 6, when it settled at its highest price since January 27.

The rally that took place the entire month of March appears to have stalled. Weighing on the market are weather forecasts that suggest a pattern developing that is too warm for strong heating demand but too cool for air conditioner demand.

The price action suggests that traders may be gearing up for relatively weak seasonal demand for heating and cooling over the next two months. This news coupled with the chart pattern, which suggests an overbought market and a loss of upside momentum, indicates that natural gas may be vulnerable to a downward correction.

I said correction because I believe we are on the cusp of a bull market this year. However, I think it’s a little too early to think about this market running away to the upside. One problem I see is that the market has once again been saturated with hedge fund buying. According to position records published by regulators and exchanges, hedge funds are more bullish about U.S. natural gas prices than at any time for almost three years.

As of April 4, hedge funds and other money managers had amassed a net long position in the two main futures and options contracts linked to U.S. gas prices equivalent to 3,280 billion cubic feet.

This data shows that hedge fund long positions outnumbered short positions by a ratio of nearly 3.6:1 on April 4, up from just 2.2 on February 28, and nearing the recent high of 4.2 on January 17.

Although the hedge fund buying may be justified, the concentration of long positions has become a source of downside price risk in the short-term, and this is my biggest concern at this time.

The chart pattern suggests that the next wave of selling pressure is likely to be labored because of potential support at $3.213, $3.170 and $3.122.

A sell-off will be justified at this time to make room for new longs to enter the market at more favorable price levels after some of the weaker longs have been taken out of their positions. I can see the market strengthening today on a sustained move over $3.272 and weakening on a sustained move under $3.213.