UNG, GAZ: Bizarre Mismatch

 |  Includes: GAZ, UNG
by: MyHappyTrading

There may be new CFTC rules in the works. These rules would limit how much of a stock could be owned, if that stock was directly based on an energy commodity.

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One obvious possibility is that some ETFs could simply shut down. But at least one, UNG, seems to be trying to dodge the sting of the possible new rules by turning itself into a closed investment trust.

The difference is that a closed fund has a fixed number of shares, and each share permanently represents a certain amount of the underlying collateral. An ETF like UNG has always functioned by issuing new shares when there is a net inflow of money, and taking the money and buying positions in the natural gas market - or alternatively, when money flows out, to retire shares by selling off the natural gas and pay off the investors selling the shares.

UNG seems to be in a transitional period.

One of the nice things about closed funds is that you always know exactly what they are worth. Take the value of the commodity and divide it by the number of shares, and that's what a share should sell for. Of course, the shares often sell higher or lower than that number. The difference is called the "premium" or the "discount".

But investors in UNG don't want to pay a premium. If they see a premium in UNG, they will go elsewhere. And guess what - that's what they seem to be doing. An alternative investment GAZ, the "iPath DJ AIG Natural Gas Total Return Sub-Index ETN", has been around a long time but existed on low volume. Until recently, it tracked UNG almost perfectly.

But suddenly, investors are leaving UNG in droves and buying GAZ instead. It has caused the two funds to unlock and decouple, with one going up and the other going down. Volume in GAZ today was over 6 times its usual. Even though natural gas was down quite a bit, GAZ rose.

Perhaps a bit of arbitrage is in order here. If you buy UNG and sell GAZ, you are betting that the two funds will eventually again track each other. Then, if the irresistable forces of the market cause the funds to track again, you make money. Of course, there may be other risks as well. New rules always can mess up a well thought out investment.

But still, it looks tempting, doesn't it?

by Skymist