KOLD: The Rally In Gas Is Just Starting


On a year-to-date basis, shareholders of the ProShares UltraShort Bloomberg Natural Gas ETF (NYSEARCA:KOLD) have seen quite a strong return, with shares delivering over 88% at the time of writing.

While these returns have been very beneficial for long traders in the ETF, I believe that the tide is turning and that in the coming weeks, the trend in gas prices will reverse.

Natural Gas Markets

In this section, I will explore the technical and fundamental factors at work in natural gas at the moment to gauge where prices are likely headed in the future. Let’s start out with a look at the chart to assess the trend and momentum of the market.

As I see it, the current status of the technical picture is shifting from bearish to bullish. Over the past year, we have seen the price of natural gas grind lower due to a persistent seasonal inventory overhang. This trend of lower prices broke several key support levels and started stalling out around April. Between April and June, the market was caught in a general range of $1.50-2.00/MMBtu with excursions beyond this zone reversed quickly.

However, over the past week, a very pivotal movement occurred in natural gas: it attempted to break into fresh lows and the move was immediately and dramatically reversed. As you can see in the chart above, natural gas prices pushed into the lowest prices of the year 4 days ago and immediately reversed the movement in a rally of nearly 20%. Additionally, as of today, momentum has turned positive as seen by the shaded area on the MACD chart which means that the most likely price movements for the time being are to the upside rather than the downside.

From a chart perspective, I am quite bullish natural gas and the current rejection of new lows combined with momentum shifting to the bullish side tells me that we may be in a several week trend of prices headed higher. I believe that this technical picture is clearly reflected and explained by the fundamental data.

Put simply, this has been a difficult year for natural gas prices in that weekly changes in stocks have generally been bearish in most weeks.

What the above chart shows is that the weekly changes in inventories have been quite bearish for most of this year in that most of the changes have occurred above the 5-year average. Last week, the EIA reported the largest weekly build in several years which was the fuel that pushed price into the lowest levels of the year, as noted in the technical section.

I believe that this fundamental picture is set to reverse in the immediate future, however, for a few key reasons. The first reason is the ongoing collapse in the rig count.

There really is no way to sugarcoat the above chart: gas drilling activity is in freefall due to sustained low prices. What this ultimately means is that at some point in the future, we will see gas prices rise as a result of constrained supplies. This may be several weeks in the future, but the pieces are in place right now which will necessitate a rally in the price of natural gas.

Already, the production decline is underway with losses seen across the major shale regions.

This does not bode well for the gas bears in that as production continues to decline, demand is likely set to recover as we move more fully into summer power burn season.

The EIA’s data is released a few months in arrears, so we don’t have the latest information – but as you can see in the following chart, this year has seen record power demand, and at present, we are rapidly approaching peak power burn.

The key driver of this growing share of natural gas demand is the shift from coal generation to gas generation – a trend which has largely been unchanged for many years.

Going forward, we are likely going to see another record demand season in that NOAA is expecting this summer to be very hot which will necessitate strong cooling demand.


When you combine all of these immediate fundamentals, the recent strength in natural gas prices makes sense. Production is in free-fall as well as the rig count. And gas is poised to break records for demand this summer. All in, the fundamentals are quite bullish which means that KOLD is likely not a sound trade at this time. This said, let’s take a quick look at the ETF specifically to examine its strategy and approach.

About KOLD

KOLD is a fairly straightforward ETF which gives a negative two-times leveraged return of the Bloomberg Natural Gas Index. This basically means that KOLD is short the front Henry Hub contract until a few weeks before settlement at which point it shifts exposure into the second month contract. As you can see in the below table of holdings, KOLD is currently short September futures.

While I am bullish natural gas and therefore believe that holding KOLD makes for a bad trade, I do have to give one key point in KOLD’s favor: roll yield.

To understand roll yield, here’s a simple chart that shows the average difference between the first and second month futures contract and the spot price of natural gas, divided by trading day of the month. The underlying data is the last 10 years of market information which means that this is a fairly broad representation of how natural gas futures tend to behave through time.

What this chart shows is that front month natural gas futures tend to start a month about 1.5% above the spot price of natural gas and end the month around parity with the spot price. This means that if natural gas prices were to generally be unchanged during a year, a long trader of natural gas futures who held the front month and then shifted into the second month close-to-expiry would lose about 18-20% per year due to roll yield.

The benefit for long KOLD traders is that they are short futures which are generally priced above the spot level of natural gas and converging during a typical month. However, while roll yield can account for 20-30% of returns for KOLD per year, the outright volatility of natural gas can dwarf this movement.

For example, if natural gas were to trade sideways for the rest of the year and the gas markets were to remain in contango, KOLD holders would probably earn 20-30% simply from futures rolling down towards spot. However, the underlying price of natural gas has changed by nearly 20% over the last 3 days which basically means that roll yield is just icing on the cake for long KOLD traders and the underlying gas movements are really what will make up the largest share of returns at the present.

Given that gas fundamentals are increasingly becoming more bullish as the rig count collapses and demand increases, I believe that further strong upside movements in natural gas are in store. This tells me that KOLD’s roll yield benefits are likely to be dwarfed by the underlying movements of natural gas at this time.


The technical picture suggests that gas has found a short-term bottom and that further upside momentum is in store. Fundamentals continue to become more bullish as demand is set to be strong while supply is diminishing. Roll yield benefits KOLD holders, but the underlying movements in gas are likely to dwarf these benefits.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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