What Bond Yields and Natural Gas Have in Common

It's been a banner year for the United States Natural Gas Fund (UNG), with the exchange-traded fund (ETF) tacking on 113% in 2021, at last check, while natural gas prices themselves are on pace for their largest yearly gain in two decades. Soaring energy demands and supply chain disruptions were under-the-radar storylines in the summer but reached a fever pitch in the fall thanks to inflation running amok, resulting in UNG hitting a two-year high of $22.10 on Oct. 5.

Last week though, UNG took a breather, down 1.5% in the last five trading days. There's potential support in place at the ETF's ascending 20-day moving average, a trendline that caught a similar pullback last month and an area that's been tested in the last 10 trading days. Amidst this recent volatility, however, are signs of skepticism building regardless of technical support; short interest has increased 32% in the last reporting period, and the 4.57 million shares sold short now account for 27.7% of UNG's total available float. With a lot of these shorts underwater, a round of short covering could help fuel a bounce off that 20-day moving average, especially heading into the winter months.

A caveat, though; short interest on ETFs must be construed differently than it would with equities. Per Quartz, experts say purchasing shorts of index ETFs like these is a way for traders to reduce risk in an investment portfolio. In other words, rising short interest may not indicate a wager on a fall, but instead a hedge to a long position within the given ETF or sector.

Regardless of hedging or shorting, short-term options traders have been loading up on puts. UNG's Schaeffer's put/call open interest ratio (SOIR), which sits in the 85th percentile of its annual range, indicates short-term options traders have rarely been more put-biased in the last year. Those put traders are paying up for a potential pullback, too, as implied volatility (IV) on UNG options is reflecting some significantly heightened uncertainty among the speculative crowd. Amid the recent technical breakout, the ETF's Schaeffer's Volatility Index (SVI) of 98% places in the 71st percentile of its annual range.

The energy shortage in Europe –especially as winter nears and the natural gas market switches to using storage from filling storage – means UNG and natural gas' stellar run in the last six months could extend as long as natural gas purchases in the U.S. remain in vogue.

Tracking UNG and natural gas is a worthwhile endeavor this winter, but it looks even more inviting when paired with the 10-year Treasury yield. Per the chart below, you can see the tendency of natural gas prices and the 10-year Treasury yield to trade in tandem. Year-to-date, the Cboe 10-Year Treasury Yield Index (TNX) has risen from 0.917% as of Dec. 31 close to 1.519% now, to the tune of a 63% rise. If one were to give a snapshot of the 2021 winners, natural gas and bond yields would be among the first mentioned.

What that means then, is that those options traders speculating on UNG's winter direction ought to be paying very close attention to the Federal Reserve's upcoming moves. On Wednesday, the Fed signaled it was ready to turn off the spigot on monetary stimulus as early as this coming November. This sent the yield on the U.S. 10-year (TNX) up 10 basis points to as high as 1.41%, a figure not seen since July. This should serve as a reminder of the interconnectivity in the markets between supply chains, energy prices, and yields. As long as this tandem price action continues, combined with the technical support stacking up with ETF's like UNG, it could set the stage for historic returns for natural gas this winter.