The Hightower Report

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DOLLAR: The Dollar has unable to sustain any sort of recovery today, and has fallen back towards the lows of yesterday’s selloff. The global rebound in equity markets continues to dampen general risk concerns, which in turn has kept the Dollar under pressure this morning. While yesterday’s Consumer Confidence number managed to lift some of the gloom toward upcoming US economic prospects, there will be an increasing focus put on tomorrow’s US Employment report during today’s session. Even if today’s data comes in fairly positive, there may be some reluctance from the market to make any strong Dollar moves before tomorrow’s numbers are heard from. The Dollar is likely to be weak during the balance of today’s session, but should find support near the 82.25 area today, as the market waits for tomorrow’s numbers.

EURO: The September Euro has been able to continue with a recovery, supported by decent Euro zone economic data, as well as some well-received debt auctions from France and Spain today. Even with the positive tone for the September Euro, it may be difficult for prices to travel far to the upside with the shadow of tomorrow’s US Employment data hanging over the market. There may be an additional boost for the September Euro, if news from today’s European Central Bank meeting produces no surprises, but a large extension of this current rebound may have to wait until US Employment data comes out tomorrow. The September Euro may see a test of the 1.2860 level post-ECB meeting, but that may be as far as today’s strength can take the market.

YEN: While the volatility in the September Yen appears to have calmed down, the uncertainty has not as prices continue to hold their ground near the highs for the move. Although comments by the probable challenger to the Japanese Prime Minister may project a more aggressive attitude towards weakening the September Yen’s current strength, the Bank of Japan will likely have the final say when stronger measures will be applied to their problem. The erosion of safe haven support due to the global equity rebound may keep any gains for the September Yen under control, at least until tomorrow’s economic data is out of the way. Look for the September Yen to drift back towards the 119.00 resistance level during the course of today’s session, but prospects for a large downside move will increase later on this week, so a move back to today’s highs may be used as an area to enter into long put option strategies.

SWISS: A strong Swiss GDP number this morning has been able to support the September Swiss this morning, which has been weakened by the loss of safe-haven support from the global equities rally. The swift pullback from yesterday’s rally above the 99.00 level may be an indication that the September Swiss may be topping out, particularly with the threat of intervention from the Swiss National Bank, if they feel the market has become too strong. The September Swiss should continue to remain well supported, but look for a move back towards the 98.25 level before considering the long side

POUND: A weak private survey of UK housing data has added to the pressure on the September Pound, which has moved back towards the lower end of this week’s trading range. The recent contrast with UK and Euro zone economic data has not been to the September Pound’s benefit, even as the longer-term UK economic situation remains fairly positive. Look for the September Pound to move towards support near the 1.5350 level, but it should hold at those levels unless there is a major reversal in global equity market strength today.

CANADIAN DOLLAR: Calmer market conditions continue to support the Sept Canadian, even as recent Canadian economic data has lost its upbeat outlook. Given the recent volatility with the Sept Canadian, a consolidation at these levels may be of some benefit as there will likely be a large reaction to tomorrow’s US Employment numbers in any case. Look for the Sept Canadian to find support near the 95.00 level, but a strong move above this trading range may wait until tomorrow’s numbers are out of the way.

TODAY’S MARKET IDEAS: The Dollar may remain weak during today’s session, but any big moves are likely to wait for tomorrow’s US Employment numbers. The September Swiss should continue to remain strong, but a pullback towards today’s lows should be considered before entering the long side.

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The Treasury market was obviously caught assuming the worst for the economy, as a series of slightly better than expected scheduled data points served to knock down Treasury prices aggressively yesterday. With the equity markets also launching into a sharp short covering relief rally in the wake of the scheduled data flow from the US yesterday, that seemed to make the macro economic reversal even more significant in scope. However, the numbers released yesterday were 2nd and 3rd tier economic readings and the readings weren’t overly impressive. However, the bear camp can certainly suggest that Treasury prices at the highs Wednesday were factoring in a fairly broad based sustained slowdown. Clearly the ISM manufacturing report caused the greatest reaction as that report offered the most concrete evidence that the US economy retained some positive momentum. Given the reaction to the ISM readings yesterday, that should make the US Factory Orders figures today a fairly important release. In fact, the ISM figures were so far off the general consensus of expectations that the Treasury market seems to have seriously called into question the entrenched view of slowing that had served to lift Treasury prices over 8 full points in the month of August. Some of the sellers in Treasuries yesterday were probably exiting positions because the stronger than expected ISM readings served to reduce the odds of further easing by the Fed. However, the market will still be presented with a very significant amount of economic news over the coming two trading sessions and the tone of these numbers are likely to send nearby Treasury prices away from current price levels which are almost at the middle of the last two weeks trading range. The bear camp probably needs to see additional evidence of resiliency in the US economy to engineer more declines ahead, while the bull camp probably needs to see evidence that the US economic track is still somewhat suspect. The ultimate arbiter of the trend is still likely to be US Non farm payrolls on Friday and not the numbers today but some traders think the better than expected US numbers yesterday, set the market up to absorb weak US payroll readings Friday without as much upside momentum. In the near term, the market will probably see the weekly claims data as a slightly more important report today as there has been some doubt cast upon the double dip recession view and therefore all numbers look to be important to the trade again. While the Press attempted to play up the talk of a bond bubble in the wake of the sharp setback in Treasury prices yesterday it will still probably take a distinct pattern of somewhat favorable economic news to prompt a sustained rotation away from fixed income holdings and back to equities. While the slowing crowd was certainly dealt a blow with the better than expected readings yesterday, it would surprising to see the numbers suddenly turn positive and the fear of slowing completely tossed aside. However, with the recent high in bonds (August 25th) coming on a significant pulse up in trading volume and spike up in open interest, some traders are suggesting that prices were technically overextended. Not surprisingly, the market discounted a very sharp drop in August auto sales at GM yesterday and that reading probably makes the Factory orders report today slightly more important than the claims or productivity figures. With the slightly better than expected ISM readings yesterday and the last remarks from an outgoing Fed President, downplaying the expectation of direct easing from the Fed, the productivity readings this morning might carry less weight than normal.

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While the stock market seems to have been oversold and expecting very bad economic conditions, the magnitude of the recovery rally yesterday probably sent a message to the bear camp. In addition to the sharp across the board rally in equities, the trade was clearly assisted by much better than expected ISM readings and that seemed to foster some respect for the resiliency of the US economy. However, in order to throw off prevailing concerns of slowing, the equities will probably need to see something positive from the US data again this morning. With an outgoing Fed member suggesting that one should not assume that the Fed is automatically poised to invoke additional stimulus, the market could have been disappointed, but seeing better than expected economic readings has potentially reduced the “need” for assistance from the Federal Reserve. In short, the bull camp would seem to need some additional help from the numbers to add to the very impressive short covering effort that was seen yesterday.

S&P 500: It would appear that the bear tilt was overstated as the magnitude of the rally yesterday seems to highlight a market that was crossed up by the number flow. One gets the sense that the bull camp might only need one positive reading from the flurry of data points this morning, to continue to claim that economic conditions aren’t as bad as previously expected. However, the market is also facing a major number on Friday morning and therefore prices can waffle in either direction, before a more significant economic decision is seen in the wake of the Friday data. For today, the September S&P could use the 1075.00 level as a quasi solid support point, especially if there is anything positive in any of the US numbers this morning.

DOW: The bull camp will suggest that the September Mini Dow managed to regain its 50 day moving average yesterday and that serves to shift the trend back up. However, the bear camp is suggesting that the numbers seen yesterday were an anomaly or that the economy remains very weak regardless of pockets of strength. It does seem as is expectations on the economy were overly negative, as a slightly better than expected 2nd tier economic reading seems to have erased several weeks of mostly negative data flows. While the September Mini Dow did regain its 50 day moving average yesterday, the market only sits at the center of the last two months trading range. Since the market only needs one positive economic report out of the flurry of readings scheduled for release today, it is possible that the bull camp will get some help, which in turn could put prices high enough to see a more pronounced negative reaction to the US Friday numbers.

NASDAQ: Unlike the Mini Dow, the Nasdaq was unable to charge back above its 50 day moving average y and the Index this morning starts the early trade below the 50 day moving average point. However, the market is hopeful of more positive news from the buyout front and perhaps even some ongoing assistance from the tech sector, as several companies continue to be in play from the merger and buy out angle. Some players might even point to favorable Euro zone economic readings overnight as a factor giving the bull camp an initial leg up today. However, given the sharp run up yesterday, it is possible that the bull camp will need some clear cut additional help from the scheduled numbers to solidify a better economic view. Critical support in the September Nasdaq is seen at 1814.00 but we can’t rule out an attempt to extend the rally ahead of the Friday payroll readings.

TODAY’S MARKET IDEAS: We can’t rule an attempt to extend the rise on the charts today, as the market was caught leaning the wrong direction and anything positive from the numbers probably sparks additional short covering buying action. We think that traders should stand back and allow the market another bounce before looking into the purchase of puts, for a hold through the Friday data flows. This week’s reaction was about being too negative toward the economy and the numbers remain soft enough to discourage full a return to the last two months highs.

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OUTSIDE MARKET DEVELOPMENTS: Equity markets in Asia and Europe are generally weaker this morning, and U.S. stock indices have posted moderate losses during the early Tuesday trade. The Dollar is generally weaker against the major currencies during overnight trading, although posting a moderate gain against the Pound. The Japanese Prime Minister will face a leadership challenge in an upcoming political party election. France has sent a proposal for stronger EU regulation of commodity markets to the European Commission. Japanese Industrial Production during July was up 0.3%, higher than forecasts. Japanese Retail Sales were up 3.9% year-on-year, higher than expectations. Euro zone Unemployment during July was 10.0%, unchanged from last month and in-line with forecasts. German Unemployment during August was 7.6%, unchanged from last month. UK individual borrowings during July were 300 million Pounds, much weaker than expectations. A private survey of UK Consumer Confidence during August rose to -18, slightly higher than forecasts. US economic numbers released this morning include a private survey index of Home Prices at 8:00, a private survey of Purchasing Managers in the Chicago area at 8:45, and a private survey of Consumer Confidence at 9:00 AM.

GOLD MARKET FUNDAMENTALS: The gold trade continues to waffle between support off the uncertainty in the global economy, and concerns of spiraling deflation. Some gold traders think that gold is set to be undermined in the face of weak economic data points ahead, but the real test will be the post-report trade action in gold. European gold traders seemed to be partially undermined by the initial weakness in equity prices today, and that would seem to suggest that deflation concerns are present again in the marketplace. A recent decline in volume is thought by some traders to be a sign that the month and a half rally in gold prices is starting to discourage some buyers, but the bulls could spin that argument around and suggest that volume seems to be declining on down days in prices. At least in the early action today, the trade seems to be poised to take a large amount of direction from the FOMC meeting minutes to be released later in the trading session. Comex Gold Stocks were 10.817 million ounces, down 63,029 ounces. Gold stocks have declined 15 of the last 20 days. Comex Gold stocks are at the lowest in the past 10 readings.

SILVER MARKET FUNDAMENTALS: The bear camp is probably a little emboldened by the weak action on the charts in the early Tuesday US silver trade, as silver prices reached the lowest level since August 25th. News of a fresh silver find from a Canadian silver miner is probably not a major impact on silver prices today, as silver recently hasn’t paid that much attention to physical supply side stories. After showing some leadership within the precious metals complex last week, some traders suggest that silver prices might have become short term technically overbought off last week’s action, and therefore the bull camp in silver would seem to need help from the scheduled data flows today. Like gold, silver seems to be getting less lift from economic uncertainty, and that suggests physical commodity market fundamentals might be regaining importance in the marketplace. Comex Silver Stocks were 110.758 million ounces, down 386,235 ounces. Stocks have declined 11 of the last 20 days.

PLATINUM: The platinum market appears to be tracking physical commodity market fundamentals during a period of slowing growth expectations. With the October platinum market reaching a partially overbought level yesterday and temporarily forging the highest price level since August 19th, it isn’t surprising to see prices this morning in the midst of a noted range down extension. Weaker equities and a negative tone toward the economy would seem to give the platinum bears the edge, but the bull camp might suggest that any favorable surprise from the data front this morning could catch the platinum market in an overly bearish fundamental posture.

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CRUDE OIL MARKET FUNDAMENTALS: October crude oil has taken on a defensive stance ahead of key U.S. GDP figure and comments from Fed Chairman Bernanke. Outside markets appear subdued in anticipation of a reduced U.S. growth forecasts from the previous estimate of +2.4% down towards +1.0% to +1.3%. In fact, that uncertain economic backdrop was echoed by a Barclay’s report released Thursday that lowered their price outlook for crude oil in 2010 by 4.8% and in 2011 by 7.6%. Additionally, markets are anxious and somewhat hopeful ahead of Fed Chairman Bernanke’s speech that he may offer new ways to stimulate demand, and that is a factor that could save October crude oil prices. However, the fundamental picture for crude oil remains flush with ample supplies in the face of slumping demand, and that has some analysts forecasting OPEC shipments of crude oil to slip a fraction in the upcoming month to 23.38 million barrels per day. There was also data released overnight from India that pegged their July crude oil production jumping over 15.5% compared to year ago levels, at the same time refineries boosted output by nearly 14.0% in the same period. Finally, the softening U.S. demand outlook has weighed heavily on WTI crude oil compared to Brent crude oil spread relationships, and that sent the premium for Brent out to new two month highs. Technically, October crude oil is showing signs of further upside potential. Volume has been above average during the recent two day advance, as the market rebounded from severely oversold conditions, and that gives the bulls hope for more. Short term support for October crude oil lies at $72.35 to $72.20, which should contain weakness barring any demand shocks from this morning’s key data flow. The short term trend provides the bulls with the edge but that edge will be erased quickly if the US GDP is below 1%.

PRODUCT MARKET FUNDAMENTALS: GASOLINE: October RBOB prices got off to a shaky start after a gap lower open, but have since recovered to their best levels of the early morning trade. Prices have recovered from severely oversold levels, but now rely on improving demand fundamentals to continue higher. Perhaps a positive result from this morning’s U.S. GDP figures and/or upbeat comments from Fed Chairman Bernanke could provide a bullish catalyst. These two factors will most likely dominate the trade today and for now expectations are set at a very low level. It appears there has been a let up in South African demand overnight, and that pressured European gas crack spreads. There were also comments from cash traders that noted weak U.S. RBOB prices have begun to take their toll on European markets. Technically, October RBOB is trying to make a turn higher and is in the process of building a base. This morning’s early rally has eclipsed Thursday’s price highs, and that now opens the door for a further push toward $1.8820. If prices can hold trade above this level for some time today, there is potential for a further run back to $1.95. The bulls have definitive edge this morning, but have to contend with significant macro developments.

HEATING OIL: October heating oil prices managed to shake off weakness overnight and bounce from $2.01 support. The combination of an extremely oversold market and a rebound from four month lows has sparked the latest rally, and that favors higher prices in the near term. Trading volumes have been running above average levels during Wednesday’s wide range reversal and on Thursday’s move higher. For now, the bulls are closing in on resistance at the $2.04. October heating oil has good upside momentum and clearance of upside resistance levels could provide a further push toward $2.15 in coming sessions. However, this morning’s macro news flow certainly has the potential to extend the upside, but also poses a very significant risk if growth expectations are not met.

TODAY’S ENERGY MARKET GUIDANCE: Without better than expected GDP readings the bear camp might be able to regain control.

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The Treasury markets reached another peak yesterday in the wake of a one/two punch of much weaker than expected US existing home sales figures and noted weakness in US equities. Recently the Treasury market wasn’t being presented with enough weakness in the equity markets to markedly degrade macro economic sentiment, but in the Tuesday trade, the market was presented with what seemed to be a roundly bullish overall environment. With the market also seeing a favorable US auction result in the trade yesterday and statements from the Fed suggesting the odds of a double dip recession were growing, there were a number of unrelated events that favored the bull camp. In looking ahead, the markets might be set to see a somewhat positive US Durable goods report, as the range of estimates for the Durables are mostly touting a “positive” reading. However, in the event that the durable goods report fails to meet most expectations, the trade could still come away from the report with ongoing concern toward overall growth in the US economy.

Since the Fed’s economic symposium doesn’t officially kick off until later this week that could reduce the flow of Fed dialogue today but we suspect that the market will be on the hunt for any statements from Fed officials in transit to the meeting. The market will be presented with another auction today of $36 billion in 5 Year notes and given the strong bid to cover ratio in other issues recently, many traders think the auction results will continue to be lightly supportive of Treasury prices.

While the Press was already touting the prospect of a Bond bubble in the headlines over the last several months, yields weren’t as low as they are now and the Notes and bonds weren’t “net Spec long” in the weekly Non Commercial and Non reportable COT positioning reports. With many US Treasury yields so low, that a minor pick up in inflation could present investors with a very minimal inflation adjusted return, the rational for snapping up US Treasuries could be called into question. However, as long as the fear of slowing and a double dip recession remains the focal point of the trade, Treasuries will probably stay in vogue.

In looking ahead to the scheduled data today, it is possible that rather dire macro economic concerns might be tempered slightly, as a housing report today isn’t expected to be as “headline soft” as the Existing home sales figures were yesterday and the durables report is actually expected eek out a positive result. With the range up move yesterday seemingly factoring in some form of additional quantitative easing move by the US Fed, some traders are suggesting that the official word on QE/asset purchases from the upcoming Fed symposium might result in a temporary peak in Treasury prices off a buy the rumor/sell the fact market reaction. However, others in the bull camp suggest that weakening in the economy is likely to continue and that the next US payroll report is likely to confirm the slowing and that could allow prices to make even higher highs.

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DOLLAR: While the Dollar has not seen much in the way of sharp movement during overnight trading, prices have held their ground so far this morning. With little in the way of recovery from global equities, there may be some residual safe haven support holding with the Dollar going into today’s session. Today’s set of US economic numbers may not have the potential to disappoint the market as badly as yesterday’s Existing Home Sales number, so the amount of further flight to quality for the Dollar may be limited at best. With US longer-term yields continuing to hold at historically low levels, the Dollar may be hard-pressed to hold on to this week’s strength for an extended period. For today, the Dollar should find resistance near the 83.60 level but the market may see a pullback over the next few days.

EURO: After a quick run higher in the wake of a surprisingly good business sentiment number from Germany, the September Euro has given back ground and drifted back into negative territory. Yesterday’s late downgrade of Irish sovereign debt continues to cast a long shadow, but cannot have come as too much of a surprise given the ongoing debt problems within EU peripheral nations. Even so, it may take more than improving sentiment to lift the market above and beyond this recent down move. Look for the September Euro to find support near the 1.2625 level, but any stronger move lower will need additional news to trigger it.

YEN: While there has been an expected pullback from the lofty highs of yesterday, the September Yen remains well into 15-year high territory going into the opening. Rhetoric from Japanese officials has had little effect in turning the September Yen’s direction around, but last night’s lackluster trade number may be a quick reminder of how damaging a stronger Yen could be to Japanese exports. The markets may be goading Japan into some concrete action, but until that occurs the September Yen is likely to hold these levels. If they do take some sort of action, then long put strategies are likely to start accumulating value in a hurry.

SWISS: The problems from the Euro zone have been able to lift the September Swiss up close to new high ground this morning, but the market appears to be reluctant to break through to the upside just yet. The market may not have much longer to wait, as Swiss economic numbers later on in the week should help to confirm a relative advantage over the rest of Europe. Look for the September Swiss to find resistance near the 97.50 level, but any pullbacks could be seen as buying opportunities by more aggressive traders.

POUND: There has been little in the way of recovery from the September Pound, which remains down near the low end of the recent sell off. While decent UK economic numbers have been there for a while, sentiment needs to improve dramatically in order to turn the market back towards the upside. Look for the September Pound to find support near 1.5375 level this morning, but we may need to see even stronger global equity markets before the Pound can turn itself fully around.

CANADIAN DOLLAR: The Sept Canadian continues to erode, but at least has avoided testing yesterday’s spike lows so far today. The benefits from the attempted hostile takeover of Potash have been eroding as well, with the elevated risk concerns and weak Canadian data keeping the Sept Canadian squarely on the defensive. Look for the Sept Canadian to find support near the 94.00 level today, but the market will need to send some signs of strength from the Canadian economy before a distinct turn back to the upside can be contemplated.

TODAY’S MARKET IDEAS: The Dollar may hold this current safe haven support today, but any sort of rebound in global equities leaves the market vulnerable to a pullback. The September Swiss appears to be on the verge of posting new highs this morning.

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The stock market enters the Wednesday trade somewhat oversold but generally seeing weakness from the Asian markets overnight. The trade was presented with a $39 billion BHP offer for Potash, but BHP tempered that offer impact with statements that they would not buy assets regardless of their price. The market might also garner some support from the prospect of a possible bidding war in the US tech sector. The market might also have garnered some lift from a better than expected German Ifo survey that was released overnight. With the added potential for a slightly positive US durable goods report later this morning, and hopes that the US Fed might shore up confidence in a “get together” later this week, it is possible that the bull camp will have some ammunition today to match up against the ongoing flow of double dip recession talk.

S&P 500: International equity markets seem to have regained some footing after general weakness was seen in Asian markets overnight. A favorable German Ifo reading and news of a possible buyout offer in the tech sector might be distracting the market from the double dip recession mentality, that seemed to be gripping the market in the prior trading session. While the markets might quickly return to double dip recession views, in the aftermath of the US Durable Goods report release later this morning, the trade is expecting to see a gain or a positive reading from the scheduled data. In short, one shouldn’t be surprised in the face of a bounce early this morning, but the real test of the bull camp could be the sustainability of the upside tilt. Our pick for a short covering target on the upside is 1055.00 basis the September S&P contract.

DOW: The September Mini Dow contract appears to have carved out a trading range above the even number 10,000 level in the overnight action. Renewed buyout news was seen from a couple different areas of the market overnight and some traders think that type of news might serve to underpin market sentiment today. Expectations for Durables and new home sales generally expect “positive” readings later this morning, but investors should be expected to remain on edge in the face of any scheduled US number release. We would expect the market to show some positive action in the face of the scheduled numbers this morning but we would also expect that optimism to wear off rather quickly and the fear of future slowing to return before the close. In conclusion, a short covering bounce is possible, but we are not sure that the market can expect to fully throw off the bearish tilt unless the numbers are much better than expected this morning.

NASDAQ: News of a possible bidding war for a tech sector asset might provide the Nasdaq with some support today, especially since the market also saw a fresh bid from BHP for Potash. As in the upper end of the market, the Nasdaq bulls really need to see scheduled US data that counters the double dip recession track somewhat, as the slowing fears appear to have become even more entrenched in the face of the massive decline in existing home sales on Tuesday morning. We continue to think that the September Nasdaq is poised for a retest of the 1750 level but the market might see a temporary bounce this morning before resuming the downside track in prices.

TODAY’S MARKET IDEAS: The market can bounce but we seriously doubt the bull camp can engineer anything beyond a temporary technical balancing on the upside. In order to stop the down trend pattern would seem to require a game changing development and without a much stronger than expected Durable goods report result later this morning, we aren’t sure where the market will get something that dramatically improves and entrenches positive macro economic sentiment.

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The outlook for the US economy seems to have become more suspect over the last month. During that timeframe, however, a prevailing trend of general Dollar weakness over the third quarter of 2010 was cast aside. The turning point came earlier this month when the Federal Reserve’s Open Market Committee announced that they would use proceeds from maturing mortgage debt to buy Treasuries, well short of potential action that may have undertaken. There has been little indication from recent US economic numbers that these steps will be anywhere close to changing the outlook for the US economy. More likely than not, this will only be the first step in what will be more substantive activity in the future. While the Fed’s “wait and see” attitude towards US quantitative easing put a scare into global equity markets, it also removed the Dollar’s tendency to receive safe-haven support. Of the two currencies that have taken up the market’s flight to quality, the Yen has seen the larger move to the upside. With Japanese officials being hostile to this current Yen strength, however, it is conceivable that central bank intervention may turn any moderate pullback from 15-year highs into a full-scale meltdown.

A more suitable choice to benefit from an extended period of Dollar weakness would be the September Swiss. Unlike Japan, Switzerland’s economy has been comparatively strong over the past year with better conditions and a better outlook than many of its European neighbors.  This has allowed it to receive safe haven support not only from the Dollar, but from any risk flare-ups within the Euro zone as well. Recent disclosures that the Swiss National Bank had taken heavy losses during their period of active currency intervention fed into the Dollar’s recent recovery, and sent the September Swiss back towards the lower end of this quarter’s trading range. The ability to limit these losses, as well as holding onto the large gains from the rally in June, are a strong indication of the upside potential for the September Swiss if the Dollar makes a return to this month’s lows.

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Natural gas prices continue to decline and so far have been down about 16.5% in August alone. This has now pushed prices back down to the bottom of a four and a half month base at 4.25 to 4.140. Coincidentally, these low levels have served as a quasi-deflationary price low throughout the year as economic slowdown fears reach a fever pitch. Short term supply is high, as storage levels stand 219 bcf above their five year average and continue to build. Elevated levels of natural gas production are expected to continue, as producers exploit prolific onshore fields (shale). Additionally, the latest Baker Hughes data pegged the U.S. natural gas rig count at 992, just below the psychological 1,000 mark.

The latest EIA Short-Term Energy Outlook estimated 2010 production to grow by 1.9% to 61.1 bcf per day. Increased production in the face of sluggish demand has served to hammer natural gas prices by more than 30% since the start of the year.

We believe there will be one more push down in natural gas prices to come, and that should take prices down to new lows for the year.

Despite the bountiful supplies, there are signs of life on the demand front. The EIA forecasted overall natural gas consumption to increase 3.8% from 2009 levels to 64.9 bcf per day, which provides a 3.80 bcf per day shortfall to help sop up excess supply.

At current price valuations, it would appear that natural gas has virtually no weather premium priced in, and with peak hurricane season now upon us, prices could jump in a hurry. While inventories remain well above their five year average, that gap has contracted for eight straight weeks and is now just under 8.0%. This tightening has narrowed various spread relationships, which has greatly reduced the incentive to build inventories.

The steep decline in prices has also attracted speculator selling and has pushed the spec net short position to extreme levels. If we discount the 2008 financial meltdown, the current position is nearing the 2007 extreme that occurred when natural gas was trading at around $6.000.

As mentioned earlier, we expect the slide in natural gas to continue and post new lows on the year to $3.800-$3.850. This has the potential to trap shorts into the market at a time of “cheap” valuations.

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