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Is it Time to Buy Natural Gas Stocks?

The U.S. Natural Gas Fund experienced a potentially key reversal day

by 6/15/2012 9:59:12 AM
Stocks quoted in this article:

While natural gas has been all the hype for the past few years, price action in the commodity has created a bull graveyard. Many speculators anticipated strong price appreciation with the advent of new technology to run cars off of natural gas, but new techniques for removing the fuel from the earth have resulted in a glut of supply, which has smashed the price for some time.

Weekly chart of the United States Natural Gas Fund (UNG) since June 2009
Chart courtesy of StockCharts.com

As you can see on the daily chart, buying this ETF any time over the past few years surely would've resulted in a loss. However, yesterday proved to be a very strong potential reversal day on the weekly inventory number. Supply came in lower-than-expected, and it appears that many shorts were caught "offsides" and had to cover their position. The United States Nautral Gas Fund (UNG) rallied about 15% on massive volume. Moves like this are oftentimes indicative of a tradable bottom.

Daily chart of the United States Natural Gas Fund (UNG) since December 2011
Chart courtesy of StockCharts.com

Since natural-gas prices are determined by futures markets, many speculators steer clear of the UNG because of tracking errors. It's a bit difficult to explain, but natural gas futures contracts expire every month, and there is a "roll cost" associated with moving into the next month's contract. As a result, UNG doesn't directly track the price of natural gas futures, and the price is somewhat understated. This creates a hurdle for bulls in UNG to overcome, and trading with a handicap is never a good situation.

If you want to take advantage of this potential reversal in natural gas, I would look to the equity market in order to gain exposure. There are a few charts that look great; although they've been in a downtrend over time, there are definite signs of a bottoming process.

The daily chart of Apache Corporation (APA - 87.17) shows a clear inverse head-and-shoulders pattern. These typically occur in downtrends, and often can indicate a key reversal. You can buy here with a stop below 80 if bullish.

Daily chart of Apache (APA) since December 2011
Chart courtesy of StockCharts.com

The daily chart of Anadarko Petroleum Corporation (APC - 64.20) looks very similar. Other tickers of interest within the sector include ECT, EQT, LNG, NBL, NGS, STO, STR, and VNR.

Daily chart of Anadarko Petroleum (APC) since December 2011
Chart courtesy of StockCharts.com

While it is tough to pick a bottom in stocks, playing key reversal points such as this can dramatically shift the risk/reward ratio in your favor. Stocks that are beaten down during times of market turmoil tend to rebound more sharply than those in nice uptrends. Given the recent move in the commodity and the overall point in the market, I believe this is a great time to begin dipping your toe into the water with natural gas equities.

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