ETF Trades: Frigid Temps Could Send Natural Soaring
By: Christopher Mistal
January 18, 2018
Recent market gains have been accompanied by a “spike” in the CBOE Volatility Index (VIX). In percentage terms, the increase in VIX would appear to be quite significant, but in absolute terms and within the context of history (even recent six month history), there likely is little cause for concern. For starters, VIX was near all-time lows on January 4 with an intra-day low of 8.92. VIX’s all-time intra-day low was 8.56 on November 24, 2017. So based upon VIX the market was rather dull. This dull assessment can be confirmed by the narrow daily trading range observed on numerous occasions throughout 2017. Now that the market has awoken and daily moves have approached 1%, VIX has picked up.
Then there is the VIX’s nickname, the “fear” index. It gets its nickname from the fact that it tends to rise when the market is in decline. However, the VIX is actually quoted in percentage terms and represents the expected range of the S&P 500 over the next year at a 68% confidence level. VIX is directionless. A reading of 12 today means a range of plus/minus 12%. Because panic selling is far more common than panic buying, elevated levels of VIX are far more common during declines hence the nickname “fear” index. Let’s not overlook the possibility that 12% over the next 12 months is also in play now.
Lastly, VIX has a historical tendency to move higher in January. In the following chart weekly open, high, low, close values of VIX are plotted in the upper portion and VIX’s seasonal trend (using data since 1990) is plotted in the lower section. Beginning in January, VIX does tend to climb higher and peak around mid-February. From there VIX then resumes course lower until mid-July and the start of the often low-volume summer doldrums. At which time VIX begins moves steadily higher into mid-October, around the same time that the stock market tends to post a seasonal low, and the typical yearend stock rally begins pushing VIX lower once again.
[VIX Weekly Bar Chart and Seasonal Pattern since 1990]
Absent confirmation from other technical and fundamental data sources, the recent rise in VIX from near historic lows to the 12-13 range is not as significant as some headlines may suggest. Economic data is firm and trending in a positive direction and daily Advance/Decline lines are also bullish further lending support to continued stock market gains in the near-term.
[Advance/Decline Line Chart]
January Sector Trade Idea
Based upon the NYSE ARCA Natural Gas Index (XNG) there is a seasonal tendency for natural gas companies to enjoy gains from the end of February through the beginning of June. Detailed in the Stock Trader’s Almanac 2018 on page 92, this trade has returned 14.5%, 16.6%, and 14.9% on average over the past 15, 10, and 5 years respectively.
One of the factors for this seasonal price gain is consumption driven by demand for heating homes and businesses in the cold weather northern areas in the United States. In particular, when December and January are colder than normal, we see drawdowns in inventories through late March and occasionally into early April. This has a tendency to cause price spikes lasting through mid-April and beyond.
This winter got off to a slow start in the Northeast with relatively mild temperatures lasting until around Christmas, but that quickly changed. The Times Square New Year’s Eve celebrations were a perfect example as temperatures plunged into the single digits. As a result of widespread, below average temperatures, natural gas inventories are near the lowest they have been in five years for this time of the year and are 13% below levels from one-year ago. Natural gas prices have rebounded from their early-December lows in response to surging demand and currently trade around $3.20/mmBtu. The situation appears to be setting up well for continued strength in natural gas and the stocks of companies that supply it.
[Natural Gas Weekly Bars (NG) and 1-Year Seasonal Pattern since 1990]
First Trust Natural Gas (FCG) is an excellent choice to gain exposure to the company side of the natural gas sector. FCG could be bought on dips below $23.95. Once purchased, consider using an initial stop loss of $22.10 and take profits at the auto sell, $30.17. Top five holdings by weighting as of yesterday’s close are: Anadarko Petroleum, Devon Energy, Concho Resources, Noble Energy and Continental Resources. The net expense ratio is reasonable at 0.6% and the fund has approximately $190 million in assets.
[First Trust Natural Gas (FCG) Daily Chart]
United States Natural Gas (UNG) could be considered to trade the commodity’s seasonality as its assets consist of natural gas futures contracts and is highly liquid with assets of over $400 million and trades millions of shares per day. Its total expense ratio is 1.27%. UNG could be bought on dips below $24.50. If purchased, set an initial stop loss at $22.00. 
[United States Natural Gas (UNG) Daily Chart]
ETF Portfolio Updates
Since the last update earlier this month, the market and the ETF Portfolio have flourished. Average open position performance is now 7.4% versus 4.3% on January 3. Strength and gains have been broad stretching across all sectors represented in the portfolio except real estate. Vanguard REIT (VNQ) is the sole losing position held. Its decline is most likely the result of rising interest rates and not because of any meaningful weakness in real estate. VNQ is on Hold.
iShares NASDAQ Biotech (IBB) is currently positive, but has remained on the sidelines recently with a meager 0.5% gain. The longer-term prospects for the industry remain bright and IBB will likely begin to “catch up” with the rest of the market in the near-term.
Our core four ETFs traded by our Tactical Seasonal Switching Strategy, DIA, IWM, QQQ and SPY, currently average gains of 6.3%. SPDR DJIA (DIA) is leading the bunch, up 9.1% since our Seasonal Buy Signal was issued. DIA, IWM, QQQ and SPY are on Hold.
Aside from today’s new trade ideas and previously mentioned ETFs, all other positions are currently on Hold. Please note most stop losses have been updated.
[Almanac Investor ETF Portfolio – January 17, 2018 Closes]
Disclosure Note: At press time, officers of the Hirsch Organization, or accounts they control held positions in IWM, XLP and XLV.