Hopping on a Gas Bounce (UNG, DXY)

We’ve been re-gearing toward the resource sector over the last couple of months and even opened a trade or two focused on the changing price of crude.

We’re continuing today in that vein, but branching out to examine some different commodities that we believe are now ready to ignite.

But first a little background.

We’ll start with the following chart of China’s Li Keqiang Index (on left) and year over year loan growth for that country (on right).

Have a look –

lkindex

The Li Keqiang Index (left) measures economic data that are nearly impossible for the communist cheats to fudge or lie about. And in a country where economics take priority over human rights, you can be sure there’s plenty of reporting shenanigans to go around.

That said, freight rail volumes and electricity consumption are verifiable data, as are loan numbers. And collectively they tell a story of a rebound after the last three quarters’ economic slump. Today, it appears that Chinese growth is returning to consensus expectations of roughly a year ago.

The China recovery story is one that’s based on a modest government stimulus package that appears to have worked – at least over the short term. Second quarter GDP rose by 7.5% year over year, and the latest quarter over quarter growth – annualized – comes out at 8%. All of which is great news for the materials and resource sectors. It’s China, remember, that accounts for an overwhelming portion of the world’s base metal, coal and lumber demand, among other commodities.

The Dollar’s Role

Beyond China and basic issues of demand, we also have the dollar playing its part in what may end up being the long awaited turn higher for commodities.

What’s the dollar doing? Well, for the last couple of months it’s been rising, and that’s made the price of many a commodity that’s priced in dollars more expensive.

Have a look here –

dxy

The dollar’s rise is apparent from the chart, having put on close to three percent against the world’s major currencies since early May.

And technical indications are also positive – RSI moved back above its midway ‘waterline’ three weeks ago while MACD surfaced some five trading sessions back, confirming that we’re once again in dollar bull mode (blue squares).

We want to emphasize, however, that if the dollar trend continues, we could see reduced demand for those same commodities, as they’ll simply become too expensive to purchase. Much, of course, will depend upon the speed of the rise and the overall demand for raw materials as we enter what many consider to be a more vigorous period of global economic growth.

All of this is reflected in the price action of the chart, where we find the dollar bumping up against overhead resistance at the long term (411 day) moving average (in red). We’ll probably encounter some selling at this level, as traders contemplate the next move for the currency. But that, too, could be positive for the resource sector, as it would afford additional time for prices to consolidate before any move higher. That stability would reduce the chances of an immediate decline in demand and concomitant selloff in the resource pits.

whichway

Of course, the situation is fluid, and there are lot of factors at play, but all told, the dollar’s move above resistance – we believe – is inevitable. It may take a few weeks or even a few months, but the dollar, for a number of reasons that we won’t elaborate upon here, is bound to strengthen.

Let’s take a quick look at the weekly chart now before we move on to our trade for the week.

From the weekly we see a picture of price pushing above all her moving averages for the first time since the beginning of the year.

We also see the Relative Strength indicator pushing above her waterline in a manner not seen since June of last year (in blue). MACD is also preparing to surface and looks to be only a week or two away from accomplishing her move above that marker.

Once that happens we should see some sustained buying from the technicians.

All of which leads us to believe that a steady push higher for the dollar against a steady increase in demand for metals and materials will likely keep prices stable to slightly higher as the global recovery unfolds.

Other Evidence

We note, too, that the Canadian Dollar has been the only major currency to appreciate against the U.S. buck over the last few months, which we take as another indication that commodity demand is on the rise. The Canadian dollar is in itself a recognized bellwether indicator of interest in natural resources, that country being one of the major commodity exporters on the planet.

And that brings us directly to this week’s trade.

wannaflow

We’ve been watching the price of natural gas plummet of late as investment dollars exited en masse from that commodity for no apparent reason, other than there hasn’t been a lot of action in the gas pits for five months.

Here’s the way it looked –

ung

After spiking higher through the winter, natural gas, as represented here by the United States Natural Gas ETF (NYSE:UNG), topped out with a massive volume surge in February of this year before sliding sideways for the next four months. Only recently have we seen a genuine waterfall selloff in the commodity that brought prices into deeply oversold RSI territory (in green, at bottom) while simultaneously completing an exact Fibonacci count lower (also in green, at top).

And what’s it all mean?

Well, we say there’s a rebound about to occur, and we also say pony ‘em up for this one, even if it is only a speculative position.

It goes like this –

We like the mid-term prospects for a bounce in price and are leaning heavily on the sub-20 RSI read and exact Fibonacci count to date to support our intention.

Wall Street Elite recommends you consider the purchase of a speculative CALL on UNG. Buy the October 20 CALLs, now trading for $1.67.

UNG closed last night at $20.83. Your breakeven for the trade is 84 cents away.

With kind regards,

Hugh L. O’Haynew, Senior Analyst, Normandy Research

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