Buy the Rumor Sell the Fact

In my October 17th Energy Alert, I stated an extraordinary buying opportunity might present itself shortly. You can access this report by clicking on the link here: Potential Slingshot Rally

In this report I pointed out a repeatable pattern formed over the last 22 years in which the fall seasonal low of Natural Gas tended to take place after a consolidation pattern and one last quick downside break. I referred to this phenomena as the slingshot effect, I said if you were holding out hoping for lower rates you could be rewarded soon, but I warned if there was a near-term downside break it would likely precede an explosive fall rally so don’t hesitate in securing your rate.

The week following my report Natural Gas did indeed begin what turned out to be a quick downside break prior to initiating an explosive rally and many of our clients took advantage of this anticipated seasonal buying opportunity. But the question is what will likely happen next?

If you have not already hedged your Natural Gas or Electricity, which are highly correlated to each other, is it too late to hedge now?

Below is a daily chart of the nearby contract of Natural Gas, which I will use to point out a possible near-term buying opportunity.

The above chart shows we are forming a very similar pattern to last year and we might have a short-term buying opportunity this week.

There are 2 points to observe in the above chart.

1. Last year, as you can see on the far left of the above chart, after a consolidation period Natural Gas briefly declined and as shown in red the slingshot was primed prior to beginning an explosive fall rally. The rally continued into early January prior to the arrival of the first polar vortex, which I show in the above chart in blue. But when the cold weather actually arrived the market experienced a brief sharp downside break.

2. This is classic a buy the rumor sell the fact trade action. We might be experiencing a similar phenomenon this week. After the slingshot was primed this year as shown in red, Natural Gas experienced an explosive rally. Meteorologists are forecasting colder than normal weather into the end of November and the first polar vortex is arriving early this year with very cold arctic air spilling into the United States this week; therefore, the buy the rumor sell the fact phenomena, which I show in the above chart in blue appears to be taking place now.

I believe similar to last year the pullback will be brief and it will be important to not delay in securing in your hedge. Commercial hedgers remember after briefly pulling back in January Natural Gas and Electricity rates resumed their rally and rates were much higher in the spring.

Commercial hedgers know historically rates tend to be higher in the spring than the prior fall’s low. In my September 12^th Energy Alert, I utilized historical data compiled since 2000 to quantify the probability of Natural Gas and Electricity rates being higher in the spring than the prior fall’s low.

Below is the chart of Natural Gas since 2000 used in my Sept 12^th report.

The eleven green arrows represented years in which Natural Gas reached a seasonal low in the fall and was higher the following spring. The two red arrows were years in which Natural Gas was lower the following spring. The one blue arrow represented years when Natural Gas was lower the following spring, but rates were much higher during the winter and hedgers would have essentially broken even with their hedges.

I explained in 11 out of 14 years or 78.6% of the time hedging in the fall benefited hedgers. In only 2 out of 14 years or 14.3% of the time it was not beneficial to hedge in the fall. Hedgers by definition are risk averse; therefore, the above odds greatly favored hedging in the fall. Also, in the one year in which hedging would have essentially been a wash, hedgers avoided the volatility experienced that year due to hurricane Katrina.

Therefore, since commercial hedgers know from a historical perspective rates will likely be higher in the spring than where they are at the present time, they will likely use this current pullback as an opportunity to reserve hedges.

Not every client’s risk tolerance and hedging strategy is the same, but we trust the above report will help you put into perspective the risk/reward opportunities at this time. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Energy Analyst