Why the Fuss over Natural Gas ETF?

People have been up in arms for months now about the troubles at the United States Natural Gas Fund, LP (UNG), the ETF designed to track the price of natural gas. And, as far as I can tell, rightly so: the whole point of ETFs is that they were meant to be a nearly frictionless, relatively simple alternative to the clunky closed-end funds (CEF) and managed products that our parents and grandparents had to contend with. But UNG recently traded at a 19% premium to its net asset value (NAV), behavior far more fitting a CEF. And until UNG begins issuing new shares, they functionally are a closed-end fund.

Why the premium? Regulators are concerned that, given its size, UNG purchases of natural gas futures could overwhelm and distort the market. Some sort of CTFC action is expected, and one review suggests that any likely outcome will result in a dissipation of the fund’s premium to NAV. That’s a good reason not to buy UNG here, and it may offer a good opportunity for a stat arb play for those with the stomach and expertise: the trade would be to buy natural gas futures and sell short the ETF (or, since the shares are hard to borrow, competent options traders will establish a synthetic short position by selling calls and buying puts with the same strike price and expiration date) on the expectation of UNG eventually returning to its net asset value.

But since hand-wringing over UNG seems to be the consensus approach, here’s a contrarian thought: UNG has, to date, tracked natural gas futures (NG) fairly well. The chart below compares UNG and NG prices in 2009:

Or, statistically:

	UNG-NG	SPY-ES
Correlation	0.969	0.998
R^2	0.94	0.99

We can agree that the spread between UNG and NG over the summer was a cause for concern among UNG shareholders (and what would’ve happened if the futures hadn’t turned south again in August?), but overall, things appear to be in order. In 2009, the natural gas ETF has tracked natural gas futures almost as closely as SPY prices have correlated with Emini S&P 500 futures. None of this diminishes the case against UNG – after all, the fear is of either a regulatory event or a market dislocation at some future date, and until those worries are resolved, shareholders are taking on risks for which they aren’t being compensated. But so far, they haven’t been punished for taking the bet.

Disclosure: No positions

Comments

[User 356224:]

To be clear, it trades in the front month, except for the period during the roll. During that 4-5 day period it transitions from the front month to the next contract, so it may have exposure to two contracts at most.

The statement that investors will "never catch the big move up" is inaccurate. The fact is, that the currently steep contango, and the process of rolling contracts is causing UNG to lose money just as an investor who was buying futures and rolling them in the same way would lose money in a falling market. If you have to sell all your positions out at $2.75, and buy the next month at $3.25 then your underlying NAV (net asset value) will obviously take a hit until things changes. That is the nature of trading the front end of a contango market.

When the market is backwardated, the opposite will be true. If you look back at the natural gas market over the past 10 years, you will see that we shift back and forth from contango to backwardation constantly. That's just the way it works. I agree with the author here, that generally speaking UNG has performed as one would expect, as long as you understand the fund's stated objectives, and you truly understand their stated processes for managing & rolling their positions.


On Sep 03 05:02 AM DJIA5000 wrote:

> You counted only the spot (front month) NG price, in reality it's
> much worse as UNG doesn't follow the spot price, it trades in many
> futures expiration that's why UNG investors will never catch the
> big move up in NatGas, opposite to investors who trade futures. Only
> futures are the real NG market, UNG is synthetic to that. Add to
> this contango (further expirations more expensive than front month)
> and it's only enough for NG to move in the tight range, UNG will
> go lower, lower and lower because of contango. It's happening already.

Sep 03 08:45 AM

[Elliott:]

The chart is chasing its own tail. Since UNG owns a large percentage of futures and swaps, of course the price movements of UNG and futures front month are closely correlated. The real question is, what would the price chart look like if UNG did not exist?

Sep 03 11:04 AM

[daniel3582:]

The way to make money in this ETF is the same way to make money in USO... find an intermediate term top, and buy puts only. You not only get to enjoy the profits from the natural weakness, but you get an added boost because of the contango effect. It's like exfoliating your skin with a sand blaster.

The last time oil was at $70 barrel, USO was $60. Now it's $36. The same thing is going to happen to UNG. People buying in now at $9/share are not going to enjoy a profit of $18/share if NG futures double. The people who are going to get the maximum profit are those who buy in at the exact bottom.

This probably goes without saying, but if you are a chartist, do not do your chart magic on UNG. Do it on natural gas futures. That will help you buy in at a profitable point.

Sep 04 07:13 AM