Looking North of the Border for Gas: A Currency Play Using ETFs

This will not be for everyone but, that does not mean it is exceptionally risky, it just has more than the usual number of moving parts.

Natural gas and the US dollar: The general thesis here is that gas prices are going up and the US dollar is going to decrease in value due to the unprecedented actions by the Fed and Treasury. So, if that is what we think, how do we play it in a single trade?

Canada...
If we go to the Toronto stock exchange we find the CLAYMORE NATURAL GAS COMMODITY ETF (GAS: TSX) and Horizon's Betapro Natural Gas Bull Fund (TSX:HNU)

Horizons BetaPro NYMEX Natural Gas Bull Plus ETF [HNU] seeks daily investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs, to correspond to two times (200%) the daily performance of the New York Mercantile Exchange (NYMEX) natural gas futures contract for the next delivery month. The Fund is managed by BetaPro Management Inc.

Their US counterparts are the UNG and DXO. DXO is the 2X oil USO ETF and as there is no US 2X natural gas ETF, this is the closest cousin to HNU. The HNU is not a currency play because we do not want to hold double ETFs for a long period as they decay (2% down day loss > a 2% up day gain). We would use it simply for a trade because there is no US version of it.

GAS simply tracks NYMEX natural gas on the Toronto exchange.

Why would we use GAS rather than its US counterpart UNG? Currency.

Natural gas like all other commodities are priced in US dollars. Inflation, or the devaluation of those dollars causes the price of those commodities to rise (or not fall as much), irrespective of supply / demand / production / use variables.

When we buy GAS on the Toronto exchange, our dollars are converted to Canadian currency to make the purchase. Now, IF the US dollar continues its devaluation trend, when we convert the Canadian currency back to dollars after we sell, those Canadian dollars buy more US dollars and we get an additional bump in our trade.

Well, how has that worked out so far this year? For the past three months the Canadian Dollar/ US Dollar exchange has gone from $.79 to $.89. Essentially that means that if we had done this trade in March, every $.79 cents we invested would have bought us a dollar worth of Canadian assets. If we exited the position today, then each dollar of Canadian assets would be converted into $.89 cents of US dollars. That is a 13% return on just he currency part of the trade, any underlying commodity move excluded.

As for the commodity, the ETF fell roughly 22% during that time span. BUT, with currency buffer, your loss would only have been 9%. So, if you think you are buying natural gas at / near a bottom at these prices and if you think inflation is inevitable, then rather than buffering losses in the ETF, the currency changes will provide additional returns...

Here is the chart: (Click to enlarge)

The obvious risk is that the US dollar begins to regain value and the trade works in the opposite direction, meaning upon conversion, each Canadian dollar then buys LESS US dollars. I think, however that risk is minimal. The US government is dead set on stopping deflation and the only way to do that is to create inflationary forces. If history tells us anything about government actions in financial matters, it is that they tend to overstep their efforts. In this case, that means that we ought to expect deflation to stop and then strong inflationary trends to begin. This devalues the dollar and causes commodity prices to rise in one swoop, a double win for our trade.

Now, for those of you who look to jump in and out in a day or so, there is no point to doing this trade for the currency reason. Currencies are not going to jump that far that fast to make the trade overly beneficial for exchange reasons. But, if you are doing this for a longer time frame, I think it may work out very well for you.

Things to consider:

1- What fees does your broker charge you for foreign markets?

2- Any additional requirements

Like I said at the beginning, this is not for everyone but I am leaning towards it being for me...

Disclosure: Long UNG

Comments

[tunaman4u2:]

What do you think of the estimates for Nat Gas inventory this week... 106 build vs the 124 last week. Why the expectations of a build so much lower in a week?

Jun 09 12:12 PM

[Soldalma:]

Sorry, Todd, but you are mistaken on this one. Since you are betting on a commodity (a tradable good) the USDCAD exchange rate should have little impact. The US dollar value of the reserves of both US and Canadian companies is unaffected by the USDCAD exchange rate. So if the CAD goes up in value while the natural gas price remains constant, the CAD price of the TSX natgas stocks should go down, as the CAD value of their reserves goes down. Of course when translated back into USD those stock prices should not move. So the USDCAD rate is largely irrelevant.

There is a small effect of the USDCAD rate, but it actually goes against your recommended trade. Canadian natgas companies have some costs in CAD for nontradables (eg., labor costs). When the CAD goes up they become less competitive.

So if you believe USDCAD is going down (that is, if you believe the loonie will appreciate) you should buy US based natgas companies, and sell the Canadian ones.

Jun 09 12:19 PM

[Shimmers:]

Todd, how does contango impact UNG's returns? What day does it roll forward the near-term contract? Isn't the shape of the curve more important than the price-level? Thanks.

Jun 09 12:46 PM

[mbkelly75:]

An interesting idea - thank you. Clicking on the chart to enlarge it gave me another copy of the chart but still in the same size. I made a PDF file out of it and enlarged it that way instead. I also believe that the loonie (and several others as well) will continue to go up against the dollar but have benefited from that simply by investing in Canadian stocks that pay a monthly dividend in the loonie instead of the dollar.

Jun 10 10:45 AM

[Fairway Jack:]

You are right....USO is a joke. In round numbers the early Jan share price was 38 and oil was 45...Now oil is 70 and share price is 38.

Jun 10 12:12 PM

[Pink Panther:]

Here's a chart of UNG divided by Natgas price (should be a flat line):
stockcharts.com/h-sc/u...

Contango loss is huge in Natgas!

On Jun 09 12:46 PM Shimmers wrote:

> Todd, how does contango impact UNG's returns? What day does it roll
> forward the near-term contract? Isn't the shape of the curve more
> important than the price-level? Thanks.

Jun 10 02:44 PM

[Shimmers:]

Thanks Pink Panther

Jun 11 09:05 AM

[elya485:]

Can anyone tell me if PINK:CYMGF is the equivalent of TSX:GAS?
I called Claymore Securities, Zecco, TD Ameritrade, Sogotrade, and thinkorswim and nobody could explain what CYMGF was.

Jun 12 11:38 AM

[polo:]

The exchange rate effect will be canceled out. If natural gas is up 10% in USD term, and CAD is up 10% against USD, natural gas is flat in CAD term. Your gain is still 10% not 20%.

Jun 16 06:51 AM