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Hopes for Normal Weather Send Natural Gas ETFs Lower

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Thanks to the return of the Polar Vortex in the Midwest, temperatures (with the wind chill) are now hitting -30 degrees once again. Although this doesn’t appear to be quite as bad as the first round of the Vortex, such extreme temperatures look to keep heating demand high, and have a huge impact on natural gas.

After all, with nearly half of all Americans using natural gas for heating purposes, it shouldn’t be too much of a surprise to note that recent natural gas reports have shown massive drawdowns in the supply of the key fuel. In just the last four reports, two have been fresh records, with an average drawdown in supplies of over 194 billion cubic feet.

Thanks to this huge use of this key fuel, prices for natural gas have been skyrocketing. Natural gas futures were approaching $5.5/mmBtu, a gain of roughly $1.5 in just a few short weeks (see Natural Gas ETFs Jump on Hopes of Stockpile Plunge).

This level actually represents a four-year high for the fuel, and helped to make natural gas one of the best performers to start 2014. However, as is usually the case for natural gas, big rallies are short-lived, especially given the calls for ‘warmer’ weather across much of the nation in February.

Forecast and Market Specifics

The outlook for the weather in February appears to be relatively normal across the East Coast. In fact, a few regions are actually looking for higher-than-average temperatures, which could reduce natural gas demand.

Additionally, the furious pace of natural gas’ rise over the past few weeks has led some to cash in their positions, particularly given the higher prospect for muted demand along the East Coast.

“The market’s collapsed after pushing up to a four-year high,” said Gene McGillian, an analyst and broker at Tradition Energy in Stamford, Connecticut for a Bloomberg article. “We’re going to see some volatility, with prices basically being pushed and pulled by the weather patterns.”

It also didn’t help that the NYMEX hiked margins for speculators holding front-month natural gas futures. The increase went from $2,750/contract to $3,300/contract and became effective at the end of the business day on Monday (see all the Energy ETFs here).

This boost in requirements, along with the weather forecast, probably helped to push some of the more leveraged traders out of natural gas for the time being. The impact of these factors was pretty severe on prices too, as front month futures tumbled to below $4.95 on the day, representing a 23.7 cent drop per contract.

ETF Angle

Thanks to this reversal, the most popular natural gas ETF, the United States Natural Gas Fund (UNG - Free Report) , traded on huge volume of over 28 million shares. This is more than four times normal, and it came as UNG tumbled about 5% on the session (read Is This a Better ETF For Natural Gas Investors?).

Meanwhile, the more spread out United States 12 Month Natural Gas Fund (UNL - Free Report) , which doesn’t focus on front-month contracts, lost just 1.65% on the day, though volume was a tad high here as well. The equity play in the natural gas world, the First Trust ISE-Revere Natural Gas Index Fund (FCG), also experienced some weakness, as the product fell about 2.1% on the session.

The winners on the day came in the inverse leverage natural gas ETF market, as these products stole the show on extreme volume. The -2x product, (KOLD - Free Report) , added about 8.6% on volume that was roughly 5.8 times normal, while the -3x product, (DGAZ - Free Report) , soared more than 13% on volume that approached 20 million shares, well above the 3.2 million share average.

Longer Term

Even with this big move, the recent trading has favored the bulls to a very large extent. UNG is still up over 17% in the past 10 days—including Monday’s 5% slump—while leveraged bull funds are doing quite well. The duo in this section of the market—(BOIL - Free Report) for 2x exposure and (UGAZ - Free Report) for 3x exposure—have gained, respectively, 34.8% and 53.7% in the past 10 days, so some profit taking is to be expected.

Bottom Line

Given some of the incredible price increases as of late in the natural gas market, a reversal was probably long overdue. Weather is expected to warm up across much of the country, and natural gas demand looks to tumble as a result. It also didn’t help that hiked margin requirements came out today, as a number of traders probably reduced their positions on this news too (also read Understanding Leveraged ETFs).

Still, natural gas can be very fickle and so can the weather. If another Polar Vortex materializes over the next few weeks, more gains could definitely be seen in natural gas. But barring that, more flat-to-negative trading seems likely in this market, particularly given the massive supply of natural gas which looks likely to put pressure on UNG and other natural gas ETFs in short-order once more.

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