Natural Gas ETF Anomaly - Is It Time to Exploit?

After briefly catching Cramer's rant Wednesday night against the Natural Gas ETF UNG and its potential to manipulate the true price of natural gas upwards given unplanned investor inflows, I figured I'd investigate a bit further to see if he was on to something. While he was railing against the existence of the ETF and was calling for the SEC to shut it down, I figured, "hey, sounds like a possible investment opportunity to me".

If anything, I'm seeking to hedge energy prices on a personal basis, and there are some other factors at play here above and beyond pure speculation. Not only does this other article from the Wall Street Journal make the case for a potential divergence from the underlying value of the natural gas assets, but this situation opened my eyes to the massive divergence between the trend in natural gas (plummeting) concurrent with oil's ascension. I realize there's never a perfect correlation here given different markets, supply/demand dynamics, etc., but historically, there isn't normally a virtual zero correlation like this.

Check out what the natural gas ETF UNG has done over the 3 month period ended Jun12 compared to oil - Oil up 50% vs. a LOSS for natural gas:

click to enlarge

Now, look at UNG shares compared to USO in just the past week. Natural Gas is up 13% vs. a flat oil return. Looks like investors have caught on to the potential gravy train here.

Here are some excerpts from the Wall Street Journal article:

With investors betting on rising gas prices, assets in U.S. Natural Gas Fund recently swelled to almost $3.7 billion from about $670 million in February, even sparking fears it could be disrupting the futures market. Securities and Exchange Commission filings show managers want to increase the number of shares available nearly tenfold. But such requests can take weeks and there isn't any telling when the SEC will act.

If the fund can't issue enough shares to meet investor demand, its shares could begin trading at prices higher than the underlying value of their holdings, breaking a key promise ETFs make to investors and possibly influencing prices in the natural-gas futures markets.

In anticipation of an expansion of shares, there may actually be near term shareholder dilution; but that may be offset by the increased price in the underlying natural gas futures, as well as the fundamentals and reversion to the mean. With the economy starting to recover, the US Dollar unlikely to rebound, future inflation expectations and this regulatory anomaly, UNG and your personal expenditures for natural gas alike could soar.

Disclosure: No position in UNG at this time; long position in USO options.

Comments

[Toeser:]

So, what's your point?

Jun 18 01:44 PM

[George Spri...:]

There are two problems with UNG. There are three components of return when you invest in commodity futures.
1) Collateral yield: Near zero T-Bill rates do not even cover management fees.
2) Roll yield: Currently about negative 50% a year due to large contango.
3) Projected change in spot price: I expect this to be positive, but maybe not enough to make up for the negative roll yield and low T-Bill rates.

Jun 18 07:11 PM

[THofler:]

Agree with George. Also, Fast Money had a nice spot on nat gas fundies tonight. While the rig count in the gas fields is way down (bullish) the actual rigs being removed are all old rigs that tend to drill low yield wells. The modern horizontal drilling rigs are still going full bore & producing high yield wells (bearish).

Add in the LNG producers who are bringing product to the US because we have the only (nearly?) large scale storage facilities, and I think the situation is grim until major economic growth kicks in.

I've got some dead money in nat gas stocks and a little in the Chesapeake convertible preferred (CHK-D). If the industry gets hammered going forward I will add to my convert position so that I'm paid to wait.

Jun 18 10:02 PM

[zzhcct:]

UNG and USO are a good pair to trade from the historical price movements and their correlation. moreover, there is some good news for natural gas, such as the control on emissions of GHG.

Jun 19 01:38 AM

[scfranklin94:]

Actually the Waxman bill gives free carbon emission credits to coal-fired generators, but nothing to nat gas fired generators, so coal is being subsidized over nat gas. Same with industrial users of nat gas; i.e. 90% of the raw material cost of fertilizer is natural gas - last time I checked there's not a single give away to Terra Nitrogen and other fertilizer makers, so the added costs will get embedded in the food prices.

Jun 19 09:02 AM

[Sovestor:]

Natural gas is not truly global commodity. It is more an American commodity. Hence, we are not sure that natural gas can move up just because oil has gone up.

Jun 19 11:07 AM

[Marc Courtenay:]

This is an interesting article that deserves more research and consideration. Please look at some of my recent articles on this topic and other collaborating perspectives. When it comes to current natural gas supplies and the volatility of UNG we all need to be better educated.

Jun 19 01:52 PM