Inside the High-Volatility Natural Gas ETF Rally

It was a brutal year for the United States Natural Gas Fund (UNG) in 2017, as the exchange-traded fund (ETF) shed more than 37% of its value over the course of that 12-month stretch. In fact, the fund was trading around $5 at the start of 2018, just prior to a reverse 4-for-1 share split executed after the close on Jan. 4 -- which accomplished the ostensible goal of pulling the ETF back from the penny-stock ledge and into more "respectable" share-price territory.

And in fact, aside from a gap lower in the first post-split session, it's been an almost straight shot higher for UNG. The ETF has rallied more than 18% from its Jan. 4 closing price (on a split-adjusted basis), ushered along by support at its now-steeply ascending 10-day and 20-day moving averages. Notably, the natural gas tracker early last week gapped above its 126-day trendline (equivalent to half a year's worth of trading days), which had previously rejected several rally attempts throughout 2017.

Helping to spark this natural gas rally was a cold snap hammering the U.S., which has contributed to a big drawdown in supplies -- with one analyst describing below-average domestic stockpiles as "precariously low" in remarks to the Wall Street Journal.

Standing in stark contrast to the bullish fundamental backdrop and positive price action described above are fund flows for UNG. Over the course of the fund's year-long slump in 2017, the ETF netted inflows of $338.04 million, per etf.com data. However, since the reverse split was enacted after the close on Jan. 4, UNG has netted $150.46 million in outflows -- effectively wiping out about 45% of last year's net inflows.

And elsewhere, implied volatility (IV) on UNG options is reflecting some significantly heightened uncertainty among the speculative crowd. Amid the recent technical breakout, 30-day at-the-money IV has escalated to 47.6% -- a lofty figure that Trade-Alert places in the 96th percentile of its annual range.

With these signs of skepticism accompanying UNG's move above chart resistance, it's compelling to note that short interest currently stands at 10.59 million shares -- down by about half from the levels of early June, but within range of the 2012 highs. This leaves UNG in position to capitalize from continued short-covering, particularly given the forecast for another wave of winter weather on the horizon. That said, established resistance in the $28-$30 region bears watching for UNG, as this area could continue to thwart upside as it did through the entire second half of 2017.

As these opposing market forces prepare to clash, we'd note that the large speculators tracked by the weekly Commitments of Traders (CoT) report could be the "bellwether" group to watch for natural gas in the short term. These investors are in the process of unwinding their largest net short position on natural gas in roughly two years, which has likely contributed to recent upside -- and last year, on the few occasions where this group verged on a net long position on futures, it coincided with short-term peaks for natural gas prices.