Trading The GUSH-BOIL Linkage

As a trader, unless you have access to some sophisticated algorithm that is able to concatenate data from several sources into meaningful information on which you base your decision, making money through leveraged ETFs can be quite difficult. Not only isoil price highly volatile, but often you do not get the timing right and, on other occasions, you may not have the patience to wait for your losses to accumulate and just end up closing at market price.

Thus, through this thesis, I attempt to devise a trading strategy based on the linkage between the prices of crude oil and LNG (light natural gas), in order to trade the ProShares Ultra Bloomberg Natural Gas (NYSEARCA:BOIL) and the Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 2x Shares ETF (NYSEARCA:GUSH), whosedetailsare shown below.

Comparison of Key Metrics(www.seekingalpha.com)

I start by exploring the linkage between the prices of the two commodities.

The relationship between crude oil and LNG

First, natural gas and crude oil remain two of the major ingredients of the energy mix globally and it would seem natural for their spot prices to be related to each other as shown in the chart below.

Next, looking deeper at the demand-supply dynamics, there has been a surprising development in the energy market over the past seven months, following the Ukrainian conflict. In Europe and especially Germany which has got a huge industrial base, large quantities of oil are now being used in industry for electricity generation in order to replace natural gas which had become too expensive. This amounts to energy substitution and has allowed many sectors of the German economy includingsemiconductorsto remain functional after the supply of gas from Russia was cut.

Now, this means that the demand for oil should be sustained thereby prompting the International Energy Agency (IEA) torevise upwardsits forecast for oil demand in 2022. However, at the same time, there are inflation-induced slowdowns in economic activity in many parts of the world, but against the backdrop of OPEC+ coming up with a proposal tocut productionby over 1 million barrels per day, it means that the price should remain high, which should provide further support to GUSH which is already more than50%up since September 2021.

Coming to the supply side, the oil market benefits from greater flexibility than the gas market as, being in liquid form, it requires relatively less complex infrastructure to be transported from one part of the world to another. On the other hand, LNG first has to be transformed into liquid within liquefaction plants before being transported within specialized vessels. When the gas reaches finally its destination, it has to be turned back into a gas at regasification plants, before being piped at manufacturing plants where it is consumed. This implies more rigidity in supply and helps to explain why, as seen in the orange chart below, LNG prices have fluctuated less, till the middle of 2021 which is explained by post-Covid demand.

Before that, from around 1998 to 2008, crude oil and natural gas prices even moved in tandem as shown by the orange chart interlacing with the blue one, before eventually decoupling. This price action is explained by a reduction in oil prices in comparison to natural gas in the 2000-2007 period due to the economic slowdown preceding the great financial recession. Oil prices recovered only in 2009 with LNG rising as well.

Subsequently, the post-2010 period also saw relatively higher oil prices because of political instability triggered by theArab Spring, where young people in North Africa and the Middle East took to the streets to protest. Thinking aloud, this period is somewhat analogous to the Ukrainian conflict in 2022 which has seen the price of WTI briefly flirting with the $123.7 level earlier this year, with the price of LNG also following suit.

Translating Commodity Price Actions to the ETFs

These price actions at the commodity level have in turn determined the path followed by both BOIL's and GUSH's share prices as they track theBloomberg Natural Gas Subindexand theS&P Oil & Gas Exploration & Production Select Industry Indexrespectively as I will further elaborate in the trading section below.

Their price actions for the last year shown in the chart below show that they have closely followed each other for the most part of 2022, till the last week of September when there has been a marked divergence.

Now, to explain this, there are also production dynamics, which are all about competition for drilling resources as LNG is often a by-product of oil extraction, and referred to as "associated gas". Thus, in 2016, the differential between oil and LNG hit its lowest since 2008 as shown in the spot prices chart above because drillers, who were profiting from upbeat worldwide demand for crude, also produced large quantities of LNG. The resulting low gas prices encouraged power companies to use more gas than coal for electricity production. This is again analogous to the high level of oil-for-gas substitution in Europe today.

Now that oil prices have reached their highest since 2014, U.S. producers have ramped up new oil drilling in the shale basins like thePermianin Texas and New Mexico, in addition to the Marcellus and Utica in Pennsylvania. This signifies more associated gas production, and with more supplies hitting the world market, this all means that BOIL will be continually under pressure.

In this respect, European gas prices are already at a third from the post-invasion peak of$332.6per megawatt as fleets of LNG tankers originating from the U.S. reach the old continent to replenish reserves. Add to this recession risks on that side of the Atlantic and there is the possibility of a trough in LNG prices last seen in March 2020 (as per the spot prices chart above), at that time due to dwindling demand following Covid lockdowns.

Trading BOIL and GUSH

Therefore, I have a bearish outlook on BOIL, which is a highly leveraged ProShares ETF aiming to provide a return that is two times (2x) the return of theBloomberg Natural Gas Subindexas I mentioned above. Also, as seen in the table below, momentum factors point to a further decline as its share price isbelowboth its 10-Day and 50-Day moving averages.

Instead, traders may opt for theProShares UltraShortBloomberg Natural Gas ETF (KOLD) which tracks the Bloomberg Natural Gas Subindex, but at two times its inverse (-2x) daily performance. Moreover, as seen by KOLD's price performances during the last one and three months, it provides for a profitable trade when the price of LNG goes down.

Comparison of Key Metrics(www.seekingalpha.com)

Adopting a cautionary tone, the issuersinsiston calculating returns for a single day, due to the compounding effect which can trim gains when the ETF is traded for longer periods of time.

As for GUSH, the oil market benefits from greater flexibility than gas, which has enabled the producing countries, despite their reluctance, to better support the increase in demand. This explains why the crude price has come down significantly from the May 2022 peak which saw GUSH overshooting the $240 level. Subsequently, the Direxion ETF suffered from a fairly sharp decline but got some support with the oil-for-gas substitution I talked about earlier. Going forward, GUSH should benefit from the rebound in the country's GDP which grew at a2.6%annualized rate in the third quarter after regressing in the first two.

Conclusion

Furthermore, with the IEA also forecasting an increase in consumption both in 2022 and 2023, surpassing pre-Covid pandemic levels, GUSH could again rise to its $250 high, last time attained in June. However, traders are reminded that with the mid-term elections around the corner, the Biden Administration will try everything within its realm to bring down oil prices namely by utilizing the U.S.Strategic Petroleum Reserve, or even negotiating with Saudi Arabia so that there are no production cuts. Therefore, expect volatility and do not hesitate to exit with a stop loss, but, note that oil prices should get support from China relaxing its strict Covid-zero policy which favors demand.

As for BOIL, its share price should be pressured as LNG is replaceable by oil and plentiful supply is available from the U.S. resulting in European gas storage exceeding93%as of October 24. This in turn means that it is less likely to be a shortage for winter, which may even imply a glut at some point in time. Thus, unless you are an experienced day trader, it is best to avoid BOIL.

To this end, the historical price movements of GUSH and BOIL as per the above chart teach us that volatility is a constant when it comes to the oil and gas trade but the linkage between these two commodities points to support for the Direxion ETF. This remains a deep linkage that starts right from production and continues to the consumption phase as power producers alter their energy mix.

Finally, just like the Arab Spring of 2010-2013 resulted in high energy prices for at least 4-5 years, the same can be reasonably expected for the Ukrainian conflict in 2022.

# US Stocks Opportunities

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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