Adding Confidence to Your Trading Decisions

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Last update: October 17, 2017, 7:39 EDT
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Description

Data is available from July 14, 2016

What if the price of natural gas was driven solely by fundamental factors and had a strong linear dependence on historical observations? Our Fair Value Price Forecast Model provides the best linear unbiased estimation (BLUE) for the price of natural gas based entirely on historical observations and seasonal fundamentals.  

The BLUE approach is very simple and straightforward, but not necessarily accurate. Still, it enables us to get a sense of what the price of natural gas should be, if it was perfectly correlated with history. We call this price “fair value” (note, the inverted commas).

"Fair value(FV) – a rational and unbiased estimate of the potential market price of natural gas. It is totally hypothetical in nature and is derived entirely from historical observations over a certain time period. FV is a statistical experiment, not a fundamental indicator. FV can deviate substantially from the market price, but still serves as an additional indicator of the potential over- or undervaluation of the commodity. 

Forecasting the price of natural gas is exceptionally difficult, especially in the long run. The purpose of the “fair value” model is not to provide an exact price projection, but rather to show a theoretical trend potential based on fundamentals. It is equally important to remember that market is forward-looking and near-term price level can be determined by price expectations several weeks from now.

For example, if market participants expect the price to decline tomorrow, they will most likely drive the price down today. That is why we often say that the market is driven by expectations. And that is also why we provide "Fair Value" price forecast for 8 weeks into the future. We published one such forecast on November 29, 2015 (at that time we were providing a 4-week forecast in the Commentary section). The model generated a price of $1.75 for December 24, 2015. This means that fundamental inputs used in the model (mostly supply and demand factors) produced a loose market balance, which under perfect conditions should correlate with the price of $1.75 per mmbtu. Whether or not the market actually closes at $1.75 on December 24 is not important to us. We are interested in the trend potential. On November 27, January contract closed at $2.212. "Fair Value" Price forecast indicated a bearish trend potential of -20.98%. The rational decision was to go short. However, you should never base your trading decisions entirely on "Fair Value" projection. Also, consider the latest storage forecast, technical analysis, forward strip, as well as your own trading psychology and money management. We update our "Fair Value" price forecast every weekday. 

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