A Potential Bearish-to-Bullish Transition in Natural Gas

Key points:

• Natural gas futures closed at a 6-month high but not a 9-month high, completing a potential base breakout.
• Historically, similar breakouts have preceded a gain 68% of the time over the subsequent three months, but the path has been volatile.
• Despite the potential in the commodity, related natural gas stocks have shown a lackluster and divergent historical performance.

A potential bearish to bullish transition in natural gas  

Natural gas trading is often not for the faint-hearted. The commodity has spent most of the past several months in a wide, sideways pattern. Last Friday, a significant development occurred in this basing pattern. Natural gas futures surged, closing at a new 6-month high. However, this high was not simultaneously a new 9-month high. This specific type of breakout, which clears the recent range but not the longer-term highs, often signals that a bottoming process is completing and a new uptrend may be emerging.

Similar breakouts suggest a choppy path forward

When natural gas completes a base breakout pattern after a 1-year low, the historical performance has been inconsistent and highly volatile. The commodity showed a positive median return and a 68% win rate over the subsequent one and three-month periods, suggesting some potential for a short-term follow-through. For related backtest, click here.

However, that momentum has historically faded. The win rate drops significantly to 50% at the four-month mark and hits a low of just 36% at the six-month mark. 

While the median maximum gain has often exceeded the median maximum loss, the drawdowns have been severe. In multiple instances, the maximum loss over the following year exceeded -40%. 

Natural gas stocks

Surprisingly, the returns and win rates of various natural gas stocks appeared lackluster, showing a clear divergence from the commodity's performance. Unlike the commodity, which showed a strong 68% win rate over the next three months, the stocks' performance was mixed to poor. Therefore, it might be wiser to consider an allocation to the physical commodity itself, a task made accessible through an ETF like UNG.

Seasonality

If history rhymes, seasonality should provide a tailwind for the next several weeks. 

What the research tells us...

Natural gas trading is not for the faint-hearted. A significant development occurred just last week when it soared to a new six-month high, hinting at the possibility of a transition to an uptrend. Even with this confluence of signals, the historical path has been volatile, with weak performance at the 6-month mark. Furthermore, natural gas stocks have historically remained on the sidelines, failing to participate with the same strength as the commodity itself.