Summary
- Price carnage in natural gas and KOLD: The nearby price probes below $2.
- Warm weather and natural gas stocks above last year’s level and the five-year average.
- NYMEX natural gas futures only reflect the price at the Henry Hub.
- KOLD is a dangerous ETF product: Leverage comes with a steep price.
- Odds favor a rebound, but crude oil in April 2020 is a dire warning for the energy commodity.
Natural gas is a wild and volatile commodity that can cause even the most seasoned trader’s head to spin. After trading to a 25-year low in June 2020 at around the $1.44 per MMBtu level, the price rose to more than $10 in August 2022, the highest level since 2008. Last year, nearby NYMEX natural gas futures traded in a $6.39 per MMBtu range from low to high, and the range was nearly 4.5 times the June 2020 low.
Natural gas is not for the faint of heart, and as I wrote in mid-January, the futures are a “ wild and dangerous ride .” In that Seeking Alpha article, I incorrectly opined that the energy commodity was in the “ buy zone” below the $4 per MMBtu level on the nearby futures contract, and I was dead wrong. However, I warned, “ natural gas is the most volatile energy commodity, and careful attention to risk-reward dynamics is necessary for success. ” While I lost money as natural gas continued to decline throughout January and February, discipline and risk-reward planning saved me from disaster. Most traders call market direction wrong most than right, but what separates winners from losers is the discipline to realize a risk position is a loser before it gets out of hand.
Last week, nearby March natural gas futures briefly traded below $2 per MMBtu for the first time since September 2020. As of Feb. 28, the trend remains lower, and the ProShares UltraShort Bloomberg Natural Gas product ( KOLD ) has been a huge winner. The trend is always your best friend in markets and deserves respect.
Price carnage in natural gas makes KOLD golden
Nearby NYMEX natural gas futures rose to the highest price since 2008 when they traded at $10.028 per MMBtu in August 2022. The energy commodity exploded higher as European prices soared to record highs. The war in Ukraine caused Russia to use natural gas and other exports as economic weapons against “ unfriendly ” countries supporting Ukraine. U.S. LNG exports have made U.S. futures prices more sensitive to international prices than in the past. Moreover, natural gas inventories last summer fell below the previous year’s level and the five-year average.
After reaching the August high, the U.S. futures fell off a bearish cliff, plunging to the lowest level since September 2020.
The chart highlights the decline that took NYMEX futures to a $1.967 per MMBtu low on February 22, 80.4% below the August high.
The Bloomberg Ultrashort Natural Gas 2X ETF product magnifies the price action in natural gas. When nearby NYMEX natural gas prices decline, KOLD moves higher. KOLD’s fund profile states:
At around $54.50 per share on Feb. 28, KOLD had $118.306 million in assets under management. The bearish natural gas ETF trades an average of over 2.83 million shares daily and charges around a 1% management fee.
The chart shows KOLD’s rally from $9.06 in August 2022 to $82.81 per share in February when natural gas futures probed below the $2 per MMBtu level. KOLD rallied 814% as natural gas futures plunged.
Warm weather and inventories have been bearish
Unseasonably warm weather conditions in Europe and the U.S. caused the natural gas market to avoid a shortage and price disaster during the 2022/2023 winter. In the U.S., inventories in storage across the country rose, putting downward pressure on natural gas prices.
The chart shows supply concerns evaporated over the past months as inventories rose to 21.9% above last year’s level and 15.2% over the five-year average as of the week ending Feb. 17, 2023. The increase in stockpiles put significant downside pressure on natural gas prices as the potential for a deficit turned into a glut of the energy commodity.
NYMEX natural gas futures are a small piece of the picture
NYMEX natural gas futures began trading in 1990 and reflect the energy commodity’s price at the Henry Hub pipeline in Erath, Louisiana.
The futures reached a record high of $15.78 per MMBtu in 2005 and a lower peak of $13.694 in 2008 when Hurricanes Katrina and Rita caused significant damage to natural gas infrastructure along the Gulf of Mexico. The first time natural gas breached the $10 level since 2008 was in August 2022.
While the futures reflect the natural gas price in Erath, Louisiana, other locations in the U.S. command significant premiums or discounts because of regional supply and demand dynamics. Over the past years, increasing U.S. LNG exports made natural gas far more sensitive to international prices. The war in Ukraine and rising prices in Europe and Asia put upward pressure on U.S. prices in 2022 before the market ran out of upside steam.
KOLD is a dangerous ETF product
KOLD is the bearish natural gas ETF that rises when the price falls, and BOIL is the bullish product that moves higher with the price. Meanwhile, the leverage offered by the bearish and bullish ETF products comes at a steep cost as time decay erodes the value over time.
Time value or theta measures of much a call or put option decreases each day as the option nears expiration if all other factors remain static. Out-of-the-money option prices are 100%-time value and shrink to zero as they expire.
The three-year chart of the KOLD ETF shows that when the natural gas price fell to $1.44 in June 2022, the ETF traded to a split-adjusted $1,745.80 per share. Time decay eroded the price, and the decline below $2 on Feb. 22 drove the price to the $82.81 high, over 95% below the June 2020 high. KOLD, BOIL, and other leveraged ETF products experience periodic stock splits when they explode higher and reverse splits when they erode.
The chart shows KOLD’s split and reverse-split history over the past eleven years. The bullish BOIL ETF only experienced reverse splits over the same period.
Leverage’s price can be very high, so KOLD and BOIL are only appropriate for short-term risk positions in the U.S. natural gas arena.
The odds favor a rebound, but be careful
On Feb. 28, April NYMEX natural gas futures recovered to over the $2.60 per MMBtu level. After falling by over 80% from the August high to the February low, a rebound in the natural gas futures market was overdue. However, the U.S. WTI crude oil futures market taught market participants a powerful lesson in 2020, the price of nearby futures is not necessarily limited to zero.
The chart shows the price carnage in April 2020 as a lack of storage caused the expiring NYMEX crude oil futures to fall below zero and to a negative $40.32 per barrel low before recovering.
While it would seem KOLD is the place to be if the more volatile natural gas futures price experiences a similar move below zero, it may not be the case. The fund summary states, “ The fund seeks to meet its investment objective by investing in natural gas futures contracts. It may also invest in swaps if the market for a specific futures contract experiences emergencies or disruptions (e.g., a trading halt or a flash crash) or in situations where the Sponsor deems it impractical or inadvisable to buy or sell futures contracts (such as during periods of market volatility or illiquidity). ” The bottom line is if the futures contract price falls below zero, there are no guarantees KOLD will rise commensurately, and BOIL will not fall with the price as the downside for a stock is zero.
KOLD and BOIL are short-term trading tools in the wild natural gas futures arena, and volatility can be like riding a psychotic horse through a burning barn. Use lots of caution with KOLD and BOIL as they could deviate from the market during periods when prices reach extremes. Time and price stops are the only way to approach these products, as protecting capital is critical in commodities that can shock market participants on the up and downside.
For further details see:
Natural Gas Approaches The Danger Zone: KOLD Looks Hot But Be Careful