Commodity ETF Alert August 2009 Issue

| August 7, 2009 | 0 Comments

Just the other day, I was having lunch with Justin.  He’s a very successful trader who has honed his skills in a unique area.

His area of specialty… Technical Analysis.

He’s a technical trader.  Instead of investing based on fundamental data, he looks to the market.  By examining price action, he enters and exits positions.

He doesn’t get bogged down in research.

He’s not trying to uncover the Holy Grail of investing.

He simply looks for patterns in the charts… and they tell him what to do.

I was so taken with our discussion on technical analysis I almost forgot to eat my lunch.  And those of you who know me know I never miss a meal!

Now, I respect Justin and his take on the markets.  But, I prefer to mix my research. I’m the type of guy who likes to look at both technical and fundamental analysis.

I’ve found they often complement each other nicely.

I took a very close look at the technical indicators.  That’s how I uncovered this month’s recommendation.

I see an amazing set-up in the charts.  I believe the Natural Gas market is poised to move higher.  But I’m not just resting my hat on the technical analysis.  I also see some great fundamental news.  And the fundamental news is also pointing to Nat Gas moving higher!

Before we get to the details on the trade, let me tell you about my research.

First, the technical analysis.

Looking for patterns and discrepancies in charts can be very telling of the future.  A while ago, I noticed something amazing taking place in the Oil and Nat Gas markets.

Just look at this chart.


I call it a divergence pattern.

Oil is up 59% since the beginning of the year, Natural Gas is down 35%.  Normally the price of Nat Gas and the price of Oil trade in tandem.  There are lots of reasons why.

Here’s what you need to know about this divergence.

Eventually these two commodities will sync back up.  That means Oil will drop in price, or Natural Gas will jump in price.  Because of the strength of oil demand and the tight control by OPEC, I believe Nat Gas will be the big mover here.  For me, it’s not a question of IF, but WHEN!

Now for the fundamentals.

It’s not just the charts saying Nat Gas is going to rise, there’s a great deal of fundamental analysis backing this conclusion.

Oil is said to account for 40% of total energy consumption in the US… Nat Gas accounts for 25%.  One of the big three uses for Nat Gas is in the generation of electricity.

The US Department of Energy estimates 90% of new power plants built in the US will be powered by Nat Gas.  It makes sense.  Power plants are going to use the cheapest form of energy available.  Right now, Nat Gas is the solution.  (Coal is actually cheaper, but the cost of cleaning up emissions is only going to increase.)

Nat Gas is also used extensively in the production of industrial chemicals and agricultural fertilizers.

I hope you’re paying attention to commodity prices.  Prices are moving higher.  Farmers are trying to squeeze every ounce of yield from their fields.  That requires fertilizer… which is made with Nat Gas.

On the industrial chemicals side, big industrial producers include companies like Dow Chemical and DuPont.

As the economy recovers, the demand for industrial chemicals will increase… and that requires more Nat Gas.

But wait, there’s more.

Nat Gas is also heavily used in the United States to heat homes in the winter.  Now, I know it’s strange to be thinking of winter in the middle of summer, but now’s the time.
While others are thinking about their tan, I’m thinking about how 58% of US households heat their house with Nat Gas.

Prices should move higher as the fall and winter months approach.  Here’s the best part… we don’t really need a cold winter to drive up demand.  Just the rumor of a cold winter, and Nat Gas prices are sure to head higher.

Where’s the risk?

I know what you’re thinking… if this looks so good, why hasn’t prices already moved higher?

Good question.

You’ll see in the chart below, Nat Gas prices are up 10% off the lows hit earlier this year.  But I believe this is just the start.

Prices are impacted by Nat Gas in storage.  Prices fall as stockpiles increase. According to the US government, storage is up over 18% from the five year average. That means we have some inventory to eat through… but let’s look at it another way.
With inventory high and prices low, producers should dial back exploration and production.  And that means higher prices in the future.

Now one more thing.

I’m not alone in my thinking.  Natural Gas industry insiders are expecting higher prices as well… and they should know.  The CEO of Chesapeake Energy, one of the largest Natural Gas producers in the US, sees prices increasing to $6 or $7.  (As I write this, Nat Gas is trading at $3.67.)

That’s a 63% to 90% jump from where we’re at today!


Natural Gas ETFs are in the news quite a bit these days.  The oldest and biggest Natural Gas ETF actually ran out of shares.  Because they can’t create new shares, they’ve been seeing larger and larger tracking errors.  It’s not a good scene.

We’re avoiding that ETF like the plague.

Lucky for us, there are other ways to profit from Natural Gas.  In late 2007, iPath launched a Natural Gas fund.  It’s called the iPath DJ AIG Natural Gas TR Sub-Index ETN (GAZ).

That’s a mouthful!

These ETNs are issued by Barclays Bank.  They’re designed to track the movement of prices for Henry Hub Natural Gas Futures traded on the NYMEX.

Remember, because this security is an ETN, it’s actually a debt instrument issued by Barclays Bank.  It’s designed to provide exposure to the movement of Natural Gas prices.  Take a look at the prospectus for more details.


It looks like Natural Gas established a low in early July.  Just a few days ago, the 5- and 20-day moving averages crossed to the upside – a bullish sign.  I think we’ll see the 20-day moving average act as a line of support.  If we get a strong move through the 50-day, we could see the commodity really run.


GAZ trades at about a 4 to 1 ratio to the price of the Natural Gas commodity.  I see Natural Gas prices moving significantly higher in the next few months.  The next resistance level on GAZ is around $17, then at $21.  If the cards fall just right, we might be close to $30 by year end.


The iPath DJ AIG Natural Gas TR Sub-Index ETN (GAZ) is trading at $15.46.
Buy GAZ up to $17.00 per share.
Our Profit Target is $29.50.
Don’t forget your position sizing.

Commodity Review

Energy JJE $26.58 $22.87 +16.2%
Grains JJG $38.54 $36.95 +4.3%
Industrial Metals JJM $35.46 $27.47 +29.1%
Precious Metals JJP $50.15 $46.55 +7.7%
Softs JJS $46.01 $41.11 +11.9%
Livestock COW $26.81 $29.08 (7.8%)
All Commodities DJP $39.42 $34.39 +14.6%


Energy had a big run this month.  Oil moved back over $70 a barrel.  Renewed optimism over the global economic recovery helped push prices higher.  Can $80 be far behind?  (Even Goldman Sachs expects Oil to hit $85 before the year is out.)

Remember, US drivers account for 10% of global oil consumption – according to the Wall Street Journal.  As the economy recovers, expect driving to notch higher.

Natural Gas prices staged a small rally in the last few weeks… It’s our pick this month. See above for the write-up.

We’re still holding onto our Oil trade.  We dipped down below $22 this month and rallied right back up over $24.  We’re showing a nice 32% gain so far… I still have $27 as a price target.  Keep holding.


The Grain picture couldn’t be more confusing.  The US Agricultural Department said they’d resurvey Corn estimates because of changing weather conditions.  So of course, Grains rallied on the news.

What the Ag Department’s going to find is anybody’s guess.

The CFTC is under pressure to reform the Grain markets.  You know how I feel about politicians meddling in the markets.  The farther apart you can keep these two the better.


The 29% jump in Industrial Metals really helped us out this month.  Our last trade in Nickel went right through the roof.  We crossed the price target.  That’s a 48% gain in less than a month! 

Everyone should take their profits.  Sell your Nickel (JJN) holdings now.

The Copper trade keeps chugging along.  We reached a new high on US Dollar weakness.  I mentioned it last month… if the US Dollar went lower, Copper would move higher.  I was right!  Another driver of Copper prices will be news of the recession ending.


After falling close to the $900 level last month, Gold’s staging a strong rally.  We’re back up over $950.  I still believe inflation will hit soon… then we’ll see Gold really run. Hold tight to your Gold position.

In other Gold news, the central banks of Europe recently signed a Gold agreement.  It limits sales to 400 metric tons per year.  This is down from the current agreement of 500 metric tons.  By signing this agreement, the banks have effectively removed a source of Gold supply for the market… in the long run it can only lead to higher prices.

Silver jumped this month as yet another Silver ETF entered the market.  By stockpiling the commodity, the ETFs are removing supply.  Something for us to keep an eye on.


Wow!  Sugar is making a major move.  Prices jumped 28% in the last six weeks hitting a three year high.  Smaller than normal harvests are expected in Brazil and India.  The weakening dollar is also pushing prices higher.

Last month I noted the monsoons could pose a problem for India’s sugar production. We’re now seeing the impact of a dryer than normal monsoon season.  As one of the largest producers of Sugar, the drop in India’s production will have a big impact on global markets.


It was an ugly month for Livestock.  This was the one group showing a big loss – 7.9%.

I’m watching our trade in COW closely.  If we don’t see a strong turnaround soon, we may exit to conserve capital.

Portfolio Changes

  • This month we’re adding Natural Gas (GAZ) to the portfolio.
  • We hit our price target on Nickel (JJN).  Sell JJN now to bank profits of 48%.
  • We’re above the buy-up-to price for Copper.  Move it to a “Hold”.

Category: Commodity Trading

About the Author ()

Justin Bennett is the editor of Commodity ETF Alert, an investment advisory focused on profiting from the ebb and flow of important commodities via ETFs. The commodity veteran and options specialist is also a regular contributor to the Dynamic Wealth Report. Every week, Justin shares his thoughts with our readers on a variety of commodity-related topics. Justin is also a frequent contributor to Commodity Trading Research’s free daily e-letter. And he’s the editor of another highly successful and popular investment advisory, the Options Profit Pipeline.