Market Harmonics
 Energy Watch

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July 4, 2010

The Natural Gas Rally - Not Just Hot Air

Last month we wrote, " The Large Specs, who tend to be the real market movers, have tenaciously remained bearish in light of the rise in natural gas supplies.  Yet, gas futures have been in a contango market, not unlike crude oil in early 2009, and prices eventually erupted even in the face of oversupply.  This deep net short position is reflecting excess bearishness in our view, and such excesses tend to give way to their opposite.  In this case, it could do so explosively in the face of massive short covering alone."  

As things turned out, a number of large commodity funds were quite literally caught short by the rebound in natural gas prices in June.  Prices shot more than 20% as a number of institutional investors who'd remained doggedly bearish were forced to cover short positions.  At least one fund we read about experienced losses into the hundreds of millions.  More "fundamental" to pricing than oversupply is market sentiment.  Unfortunately, some investors still insist on learning this lesson the hard way.

As we also mentioned in last month's report, "our expectations would be for a similar ABC advance to develop to minimally retest the previous highs above $6."  The chart above shows the 5-wave advance that produced the Wave A rally, which peaked at $5.20 on June 16th.  The subsequent Wave B pullback, which continued into the last half of the month, was itself a 50% retracement of the Wave A advance.  Thus far, the advance has been tracing out in textbook form.  

Assuming Wave B has ended and does not extend, then the next leg up, Wave C, should be in its early stages.  There is typically a relationship of equivalence in the lengths of A and C waves, which in this case should see an attempt to retest the January high above $6.  

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