Weekend Ramblings

So far, the most anticipated correction of all time has been not surprisingly, pretty lame. Despite all the major worries of Spain, slowing economic data, high gas prices, ect, it was only good for a 4% drop from the YTD high and the market has recovered about 2/3 of that drop. During this decline I noticed a run for the exits via AAII, NAAIM, and mutual fund flow data. Also, bonds rallied sharply as the 10 year is now back to sub 2%. Remember when I said that the 2 best timing indicators of late has been bond yields and mutual fund flows? During the past 3 years you would only see a meaningful correction in the market (ones greater than 5%) when bond yields had been rising significantly for several weeks and mutual fund flows were at least somewhat positive during that time as well. Conversely, important bottoms have been made when the opposite was true. Prior to this "correction", both bond yields and fund flows (by some accounts) were in positive trends for a few weeks but it was a rather minor reversal of the trends that had been in place with bonds and fund flows since last summer. So, because the reversal was so minor,  I'm not surprised to see the market only fall as modestly as it has.

My best guess is that we will see May turn out to be a positive month and then we'll stall again in June as the market further consolidates this big move since November.  I'm not a major fan of seasonality but one thing I've noticed in the past several years is that June has been a perennially shitty month in both bull and bear markets while December has been a perennially good one. Based on what I see in the historical charts with my naked eye, every June since 2000 has been negative!

This "correction" has already worked off a lot of the overbought condition in the market from a trader sentiment standpoint. I say "trader sentiment" because such things like AAII sentiment surveys are only relevant to the ST/IT.   The true, underlying LT structural sentiment has been one of ingrained pessimism since late 2008. Go ask your neighbor or uncle what he thinks about the economy or the stock market. Go to globefund.com and see the list of the most popular fund quotes. Go to your local book store and see the titles that dominate the business/finance section. You will get the same message - doom and gloom. But knowing that the dumb money herd is still bearish is not going to help you time the IT moves in the market. The herd was still negative prior the flash crash and last summer's meltdown for example. Just keep in the back of your mind that no matter how bad or scary things may seem in the market, the dumb money herd was never anything close to feeling positive about the economy and so somehow, someway the market will be able to recover from whatever funk it may find itself in and eventually make new highs shorty after. This certainty requires a leap of faith and I'll be the first to admit that it can be difficult to do so when the shit hits the fan like it did last summer.

Switching gears now to talk about  the energy markets. There's some interesting developments happening specifically in nat gas. It's amazing what can happen in a span of a few years. In 2008, the nat gas price hit $14/mcf and just last week it broke below $2 hitting $1.87 before popping a bit back to $2.20. At the most recent low, the nat gas price traded 40% below it's 200DMA. This 40% deviation from the 200 DMA is important because this is the type of extreme you tend to see near the end of a major panic or mania. With the equity markets, it happened at the November 2008 bottom and then again at the March 2009 final bear market bottom. The first time nat gas hit the 40% threshold was in Janurary at about the $2.25 level and now it happened again at the $1.87 level.  If the price breaks above $2.50, I think there's a good chance that the final bottom has been made. Conditions are certainly in place for a long term bottom to be in. First there's sentiment. Take a look at the following chart.

Sentiment towards nat gas is the complete opposite of where it was at the major top in 2008. It's pretty much as depressed as it can be. Not only that, but bullish sentiment has been below 25% since the start of the year. While that certainty has been justified given the price action, such chronic, low sentiment is what you see in the final blow-off phase of a bear market just like the chronic bullish sentiment you tend to see in the blow off phase of a bull market.

Next there's rig counts for nat gas. The current number of rigs in the US drilling for gas has dropped to 613 - a 10 year low. That's about a 35% drop from October levels. This 600ish level of rigs is also consistent with what you see at major bottoms in the nat gas price if you look at history.

We all know that warm weather and oversupply from shale drilling were the culprits of the recent crash in the nat gas price, but the oversupply problem is being addressed via production shut-ins announced by the majors and the rapid decline in the rig count which is now at historical lows. Weather conditions, although important, will have short to intermediate term impacts on the price. It's the structural demad issues you need to focus on and we are seeing new sources of demand emerge. We are seeing increases in the use of nat gas from utility companies switching from coal, conversion to deisel and demand from natural gas powered vehicles. These sources of demand have not yet been significant enough to overcome the oversupply imbalance, however, it seems as if it's just a matter of time before they will if nat gas prices stay at these levels while new supply is being curtailed. Then there's the big kahuna - LNG. This has the potential to be a massive force on the demand side, one that was never there before.

I've been noticing a lot of buzz lately about the LNG sector ever since Cheneire Energy in the US has received approval to build a LNG terminal. There's also a LNG buzz up here in Canada as well. It's pretty clear to see why there's so much excitement.  Here in North America the price of nat gas is hovering at $2/mcf whereas in Europe and Asia the price of nat gas ranges from $11-$17/mcf ! So, it's quite lucrative for North American producers to convert the nat gas to LNG and export overseas. The move towards LNG exporting is starting and when this achieves critical mass...look out above!  Here's the issue though....it takes time (at least 2 years) and a ton of  money before any proposed LNG terminal can be built and so LNG demand won't be a significant factor in the nat gas price just yet but when it does, it has the potential to make for a massive impact.  In the meantime, it's best to focus on the supply and demand factors that are relevant right now.

The bottom line here is that it's time to take a serious look at the nat gas sector. It's tough to tell exactly when all of the bullish forces that I mentioned will start making an impact on the price but it seems to me that it's just a matter of when, not if, a major nat gas bull market will begin. It will be interesting to see the market's reaction to the Q1 earnings reports of the pure players like ECA and UPL which are going to fully reflect the collapse in the nat gas price. There's lots of smaller players in Canada as well which have been hammered. What I want to see is more base building behavior in these stocks and the market showing a willingness to ignore any poor earnings reports thus reflecting the possibility that the bad news has already been priced in and better times lie ahead. A lot of contrarian investors have been hurt badly trying to catch the bottom of this sector and I don't wish to be one of them, but given what I see out there, it's time to be on high alert of a major bottom in the sector. Big money is made riding big trends and it seems to me that with nat gas we could be near the beginning of such a trend....and it may have already started.