Natural Gas in an Unnatural Slump

It's not the news, but a market's reaction to the news that's telling. If a market doesn't do what it's "supposed to" in a given situation, that could be a signal to take a position going in the opposite direction of that implied by the news.

Take September natural gas (NGU2:NYBOT). Much of the country has been smoldering under a heat wave that has topped 90 degrees Fahrenheit. Yet during this time, natural gas has been unable to mount a convincing rally. Higher usage for electricity generation by utility companies as well as from consumers to run air conditioners should have ramped up demand. A spike in demand should have supported or even spiked prices. Natural gas was "supposed to" have rallied. It didn't.

If natural gas can't move higher on what will probably turn out to be the hottest fortnight of the summer of 2002, it's going lower. The key point -- which can be applied to any market -- is that if a market can't move higher on bullish news, look out below. Conversely, if a market doesn't move lower on bearish news, that is a strong indication the market will rally.

Even before the start of the heat wave, natural gas gave an indication of its weakening hand. The early clue to the possibility of further downside action was the outside bar down and pullback-from-a-low trigger I pointed out in a recent column.

Notice how natural gas was never able to surpass the high of the outside bar down from July 25, a bar that held almost precisely at the 38.2% retracement of the decline from the June high. A second outside bar down on Aug. 1 set the stage for Monday's big drop. The negative price action suggests natural gas will retest contract lows.

Also in the energies, a focal point supporting the price of crude oil and its products has been the threat of military action against Iraq, one of OPEC's largest producers. While a strike against Iraq would likely cause oil to spike, the energy market does not appear to have adequately priced in a slowing economy amid calls by OPEC members to raise output quotas.

Weaker-than-reported GDP figures, the lowest reading in consumer confidence in nine months and a tepid pace of job creation are among the factors that have traders worried the economy will fall back into recession. Slower economic activity cuts the demand for crude oil and its refined products.

On the supply side, OPEC member Algeria recently asked the cartel for a larger output quota. Although the North African country is only a minor player, contributing less than a million barrels a day to global supply, the request to hike its output could have a snowball effect.

If Algeria receives a higher quota, more prominent members with larger production capabilities will also likely ask for, and be granted, higher output quotas. This comes at a time when OPEC influence is waning due to growing capacity and exports from non-OPEC producers such as Russia. Russian output is up more than 8% so far this year, to 7.42 million barrels a day.

September crude oil (CLU2:NYMEX) has been wedging higher, but has been unable to crack $28 a barrel. A breakdown out of the wedge (a reversal pattern) shown below points to $23 a barrel.

September unleaded gasoline (HUU2:NYMEX) has a more convincing pattern. Its big down day on Aug. 1 closed below the consolidation range shown in the following chart and finished at its lowest point in three weeks.

Finally, notice how September cocoa (CCU2:NYBOT) has shown only a weak recovery after gapping to a one-month low on Aug. 2. Defined-risk shorting opportunities exist on entries below the gap. Consistent closes above the gap and cocoa's 10-day moving average define the risk on this trade.

Marc Dupee is an independent trader and co-author of the book The Best: Conversations With Top Traders. Dupee was formerly markets analyst and futures editor for TradingMarkets Financial Group. At time of publication, he was short natural gas, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback to Marc Dupee.

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