Some Commodity ETFs Are Breaking Down

This is not supposed to happen in the world of exchange-traded funds (ETFs). Some rather large and persistent premiums to net asset value have emerged recently.

The affected ETFs are in the U.S. commodity sector. Of note, as mentioned in my Sept. 10 column on natural gas prices, is the United States Natural Gas ETF (UNG). Its premium first surfaced about a month ago and has now risen to 20%.

Normally, ETF premiums (or discounts) are miniscule because of the arbitraging mechanisms behind ETFs. When there is a premium, new units are issued to large investors in return for a piece of their portfolios. The large investors then distribute the units to retail investors, capturing an arbitrage profit (until the premium disappears). Vice versa for when there is a discount in the ETF’s units.

But several ETFs tracking commodity prices have stopped issuing new shares. That’s because U.S. regulators are imposing limits on the positions they can take in the futures market. There are concerns on Capital Hill and elsewhere that the ETFs, previously exempt from trading limits, are pushing up commodity prices too much.

Hence, premiums to net asset value are accumulating as investors pour into the commodity ETFs and bid prices up. In effect, these ETFs are trading like closed-end funds at present. Buying them at this stage thus exposes the investor to the risk of incuring a loss in the event the premium evaporates (ceterus parbus).

Comments

[tripleblack:]

Count on government intervention to convert a potential, manageable problem into a real unmanageable one.

Sep 11 07:37 AM

[Omry:]

How are you calculating the current premium?

Sep 11 09:50 AM

[Ketch35:]

Sic! Ceteris Paribus

Sep 11 10:03 AM

[mn33:]

thanks for boring us with the same information that many other writers have been saying for the last month.

Sep 11 11:37 AM

[Mad Hedge F...:]

uutn. Since I have had such a hot hand in natural gas, many have asked me to comment on yesterday’s surprise announcement that the ETF, UNG, finally got permission to issue new shares. The easy answer here is that UNG will crater. There is no reason for the fund to trade at a premium whatsoever, which at one point traded as high as 20%, an overvaluation you normally only see in closed end funds at bear market bottoms. These ETF’s are simply pass through vehicles which make it easier for investors to own NG in stock form when they are legally unable, or too lazy to open a futures trading account. They should never trade more than 1% out of line with the underlying to account for the admin and execution costs of running such an instrument. The people who made the killing here were the handful of hedge funds that were able to borrow UNG shares, sell them short, and go long the futures, locking in a guaranteed 20% spread. They will cash in their profit next week. Something similar is still going on where smart industry players have locked up salt caverns to store gas, buy it cheaply on the spot market, and sell it forward. This is possible because yesterday you could buy October at $3.25/MCF and sell it for April delivery at $5.32, giving you an annualized return of 127%. Leverage that, and you are talking about some serious money. If you were wondering where the money was coming from to buy those G5’s, this is it. The fundamentals for the industry are still terrible, and there is a risk that the market could completely grind to a halt when the country runs out of storage, so the volatility will remain huge. This week’s move explosive 44% move from $2.40 to $3.44 was nothing more than pure short covering. I expect a quick double in NG once the storage issue is resolved, and the cheapest, cleanest, and most liquid way to participate is though the futures. If you need help in how to do this, e-mail me at madhedgefundtrader@yah...

Sep 12 02:10 PM