Oil Jumps Above $71; Natural Gas Hits $5, Set to See 'Sizeable Rally'

After falling more than $1 yesterday, the price of crude oil rallied more than $2 in trading on the New York Mercantile Exchange Thursday, settling above $71 a barrel. Reaching above $5 in intra-day trading, the price of natural gas rallied again today to close just below the $5 mark.

In trading Thursday, the price of crude oil gained $2.12 on the NYMEX to close at $71.69 a barrel. Reaching an intra-day high of $72.55, the price of crude oil was supported by better than expected US unemployment numbers and retail sales that spurred a rally on Wall Street and a devaluation of the US dollar.

The US Labor Department today reported that first-time unemployment benefits claims fell to a nine-month low last week, and Thompson Reuters reported that select major US retailers saw an increase in September sales. The positive news helped to ignite the stock market, while the value of the dollar fell to a new low.

Devaluation of the Dollar Spurs Oil Investment

"Oil had a couple of things going on today -- most notably, the dollar went through its low from September," explained Darin Newsom, senior analyst with DTN, a market information service in Omaha, Nebraska. "So we've got this pressure in the dollar, and that is sparking all kinds of buying interest in commodities."

Investment in the commodity is increased when the value of the dollar falls because oil is traded in the greenback and investors holding other currencies are able to purchase oil at a cheaper price.

"We saw the dollar coming under pressure today on the idea that maybe the economy is still going to sputter around here for a while as we go into the fourth quarter, early first quarter of next year," Newsom continued. "Even though the Federal Reserve hinted that in 2010 we would start to see interest rates possibly start to go up, certainly there is no indication now that is going to happen any time soon; and again with the dollar moving to the new low, it would seem to confirm that idea that we're in this time where we're going to just hold low interest rates, and the dollar is going to be allowed to come down."

Additionally, investors holding US dollars tend to invest in oil as a hard asset and a hedge against inflation.

"We didn't see a lot of commercial buying in the market today," Newsom added. "My thought is what we saw was mostly non-commercial investment buying coming from the weakness of the dollar and the strength of the Dow."

Range-Bound Trading Continues

"The interesting thing about crude is that it still seems to be lacking that fundamental push because we cannot break out of this range that we've been trading in," Newsom said.

The price of crude oil has been trading in a range between about $65 and $75 for some months now, unable to break out to the top or the bottom.

"We're staying in that $10 range," he added. "We don't have the fundamental support to push us beyond that, and we've got a lot of non-commercial buying coming in."

Because the market is being supported by non-commercial investing, rather than commercial buying, the price of crude oil has been supported beyond its supply and demand fundamentals, buoyed by economic news and a hope that the end of the recession will spark an increase in energy demand.

"It's just not as strong as a rally as one that has the other side of the market behind it, that has bullish underlying fundamentals, or fundamentals that are growing less bearish, even that when we see the spreads or the contango weakening," Newsom explained. "Now, we've seen that in crude oil, but it hasn't been consistent; it hasn't been this sharp angle in the spread chart that would indicate that we've got this great deal of buying coming in."

This type of situation could result in a sharp decline in the price of oil, similar to that seen when oil hit a high of $147 in the summer of 2008 and then fell to the low $30s within months.

"When the market starts to turn back down, and non-commercial traders begin getting out, it leads to a very sharp, very volatile sell-off because the market usually tries to return to where its underlying fundamentals might be indicating buying could be," Newsom continued.

Newsom contends that the spreads in crude oil are not wide enough to see the market drop as dramatically as the 2008 sell-off. Furthermore, forecasts for a colder winter have helped to strengthen future demand.

"I think as we get further into winter, and depending on how harsh of a winter it is, I still think we could go down into that $61 to almost $54 range," Newsom predicted. "I think that's going to be where some pretty solid commercial buying starts showing up. Now, if we break out of the top side of this market, then that could change everything."

Natural Gas Tops $5, Could Make A Run Even Higher

The price of natural gas hit $5.045 in intra-day trading, settling back down to $4.963 per thousand cubic feet on the NYMEX Thursday. Despite hitting seven-year lows just weeks ago, natural gas has been able to rally over September and October to much more favorable prices.

"We crossed over that $5 mark the first time since mid-January 2009," stated Newsom. "We've gotten some support, again non-commercial in nature, but we've also seen the contango in the natural gas market start to weaken."

While the supply and demand fundamentals remain bearish, natural gas spreads have been tightening over the last two weeks.

"Short-covering as the Dow is rallying is providing support, and we have these forecasts for a colder winter," Newsom added. "We've got freezing temperatures and snow already moving into parts of the Midwest this weekend."

The impending winter heating season has helped to turn the overly bearish market, and short-covering has also helped to strengthen natural gas prices.

"Is the market trying to tell us something with this bullish signal that it established at the end of September?" questioned Newsom. "It very well could be because we have seen the market start turn just a bit. Is it ready just to skyrocket?"

Because the price of natural gas has been so low for so long, the analyst foresees a chance for natural gas to really climb.

"If ever there was a market that has been beaten down for so many years that could turn on its heels, it certainly would seem to be natural gas," Newsom concluded. "I think for the largest part because the net-short position was so large that if everyone tries to run for the exit at the same time, it's going to create quite a buying frenzy. This market is poised to possibly post a pretty sizeable rally."