UNG, GAZ: Bizarre Mismatch

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.

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

Comments

[Ron Rowland:]

Before anyone attempts to implement the proposed arbitrage outlined at the end of this article, they should check the premiums on each security. Last time I checked (around noon on Friday), UNG was at a 16% premium and GAZ was only at a 7%. This suggests that a more appropriate arb might be the exact opposite of what is recommended here.

Aug 23 01:27 PM

[tc1:]

A question i have is: What are the plausible scenarios for UNG's and GAZ's shareprices going forward into Fall-Winter, the obvious seasonal time for greater demand for nat gas (even if we have a milder winter in the north and northeast USA), and also ostensibly the time when our recovery (however anemic) is further underway and industry is also demanding more nat gas supply?

Even during the Crash last Fall, UNG was still trading as high as $28-$30 in Oct-Nov. What could UNG (and GAZ) reach this Fall, factoring in such variables as 1) problems with the UNG etf, 2) the flight of many investors to GAZ, 3) the massive cutback on supplies due to the recession, balanced with 4) the greater number of shale sources for nat gas???

Comments welcome.....

Aug 23 04:23 PM

[SCN4:]

I could not find the roll dates, and daily holdings information. Does anyone know where to find this?

Aug 23 11:20 PM

[H. T. Love:]

Scroll through my comments. I've posted those links a lot.

A starting point is here www.unitedstatesnatura.../

HardToLove


On Aug 23 11:20 PM SCN4 wrote:

> I could not find the roll dates, and daily holdings information.
> Does anyone know where to find this?

Aug 24 09:30 AM

[naturallight:]

I’ve read that UNG holds the front month futures and then rolls to the 2nd month, while GAZ holds the 2nd month and then rolls to the 3rd. I can’t find independent confirmation of whether that’s true, but if so, it might make arbitrage a little trickier.

Aug 24 03:35 PM

[MPD:]

Be careful, GAZ and UNG hold different contracts which means taking on basis risk (and note how large the premiums between contracts are at the moment)

MPD

Aug 25 10:32 AM

[SCN4:]

Thanks. Yeah I see the UNG holdings and roll dates, but cannot find the details on GAZ. Am I totally missing something on their website? I am holding UNG and trying to figure out the GAZ.


On Aug 24 09:30 AM H. T. Love wrote:

> Scroll through my comments. I've posted those links a lot.
>
> A starting point is here www.unitedstatesnatura.../
>
>
> HardToLove

Aug 26 12:04 AM

[Skymist:]

My article was not meant to imply that arbitrage could be taken against the two ETFs theoretical value, but against their relative value in the context of recent history. Track the two funds back and they are a match - except for that particular day.

The opportunity is gone now. GAZ is also suspending share issuance like UNG, and the funds are rapidly becoming less useful.

Aug 26 02:00 AM

[Barbarous R...:]

As more and more people come to understand this UNG silliness, I have to think that the premium will get crushed. What's to stop some smart futures guy from simply going long the futures contract and roll it as UNG does -- while all the while shorting UNG? Thereby locking in 20% risk-free.

An equity guy could even go long the zero-premium HNU in Canada (adjusting for leverage of course) against a short in UNG.

Or a bolder investor could go long a basket of gas-related stocks and short UNG to benefit from both the the ridiculous premium and the likely near-term drop in the commodity as storage is filled in the next 4 weeks.

It's hard for me to imagine any rational investment strategy which would involve going long UNG here.

Aug 28 02:51 PM

[H. T. Love:]

I just went to the iPath site. I was not able to find a schedule of roll dates either.

HardToLove


On Aug 26 12:04 AM SCN4 wrote:

> Thanks. Yeah I see the UNG holdings and roll dates, but cannot find
> the details on GAZ. Am I totally missing something on their website?
> I am holding UNG and trying to figure out the GAZ.

Sep 01 07:07 AM