United States Natural Gas Fund: A Contrarian Perspective

Mark Twain, never regarded as an investment great, did have experiences with financial markets and the madness of crowds. His famous quote: "whenever you find yourself on the side of the majority, it's time to pause and reflect” perhaps made him one of the forefathers of contrarian thinking.

Although he probably did not realize it, Twain hit the essence of investing on the head, that is, the art of investing is knowing more or less when to go against popular opinion; or to put it another way, Buy Low Sell High.

This brings us nicely along to investing in natural gas. Bearish sentiment, by all reasonable estimates, is at record levels. Suggesting that the majority (the crowd) have either sold long positions or hold short positions. Yes the fundamentals “appear” to be very bearish but these are already reflected in the price.

This short discussion concentrates on the perceptions of fundamentals and key drivers of gas prices.

The there is enough evidence to suggest that 12 months from now natural gas prices (and UNG) will be materially higher. We say this essentially because of one factor – the strength of the energy market; crude oil prices, oil services and coal producers.

An investors outlook on natural gas prices should center around the outlook for crude oil. There is nothing more to it than that!

Consider this, if crude goes to $100, will natural gas prices remain at current levels? For that matter will coal prices remain at current levels if crude goes to $100? We think not.

Confused, what about the poor fundamental outlook? Yes we are aware of the banter going around with respect to stockpiles, new shale supplies, LNG etc. But are fundamentals that bad? Obviously the crowd perceives them to be that is why Natural Gas is trading at multi-month lows. But we suspect that perceptions may well change quickly as oil begins to approach the $100 level again.

Something is driving crude prices and commodities in general higher and that something is ultimately going to start driving the price of natural gas higher. We don’t know where the bottom for natural gas is, but we suspect that we have either just witnessed it or, if not, it is not too far below the $2.50 level.

Perhaps the bears need to stop and think, they are now the majority, where is the marginal seller of natural gas going to come from if the majority have already sold or hold short positions? We have been bulls on natural gas for some time based largely on the foregoing discussion (click here for previous articles).

As with Mark Twain, sometimes it takes an outsider to see the obvious.

Is anyone else with us?

Disclosure: long UNG

Comments

[Mad Hedge F...:]

yyt Since I have had such a hot hand in natural gas (see my call to sell at $4.30 in June by clicking here ), 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 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 through the futures. If you need help in how to do this, e-mail me at madhedgefundtrader@yah...

Sep 13 06:59 AM

[apppro:]

In response to Mad H.:
More deplorable promoting of one's own self interest is what makes me puke here! Yes, the premium in UNG should not be there, BUT to say the ETF will "CRATER" is just more of the hysterical rumorboarding we got throughout the banking crisis. (We don't here that 'N' word anymore do we!) We might sell off an addtional $1.00 or so, but say that is cratering - get real. And if by his own admission, if the price of NG $6.00 is in the future then the premium is meaningless.
What makes the Mad's blog even more deplorable is the OUTRIGHT attempt to ADVERTISE his own business.

Come on Seeking Something - monitor these posts for at least self-serving financial gains. Oh yeah, that's what these blogs are all about. Sorry!


On Sep 13 06:59 AM Mad Hedge Fund Trader wrote:

> yyt Since I have had such a hot hand in natural gas (see my call
> to sell at $4.30 in June by clicking here ), 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 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 through the futures. If you need help
> in how to do this, e-mail me at madhedgefundtrader@yah...

Sep 13 08:17 AM

[Fred Pollack:]

On Friday UNG closed at $10.59, and its NAV was $9.12. In after hours, UNG said in an 8K filing that it would start creating new shares on September 28th. This will close the premium to NAV. In after hours trading, UNG stock was already off 50 cents.

Unfortunately, buyers of UNG think they are buying Natural Gas, but they are really buying the near term futures. Usually, this is the same thing. The exception is when there is significant contango. And, now the contango is severe. The November futures are now priced $1.05 over the October futures ($4.01 vs. $2.96). From UNG's prospectus, over the next 4 days, starting Monday (September 14th), UNG will sell its October futures and buy November Futures. If you do the math, you will see that UNG will then own 25% less natural gas. Or stated differently, for UNG's NAV to remain the same over the next 4-5 weeks, spot prices of Natural Gas have to increase by ~$1.

There are valid reasons for NatGas to get back to $5+. But the current storage situation suggests that this seems unlikely in the short term (next 1-2 months, if not a little longer). Unfortunately, neither UNG nor the futures make this easy. For example, the January futures are already priced at $5.06.

To understand the dangers of investing in UNG, when there is severe contango, you need only read page 16 of the UNG prospectus (pg 22 of the PDF download). You should read the 1/2 page on this, but here is just one sentence: "In the event of a prolonged period of contango, and absent the impact of rising or falling natural gas prices, this could have a significant negative impact on USNG’s NAV and total return."

Disclosure: I have short position in UNG, via being short uncovered calls for Sep, Oct, and Jan.

Sep 13 09:07 AM

[bertil:]

I suppose or Mad Hedge is very excited about his point of view with lots of free time.....so just give him space.
Fred Pollack's piece is really informative and easy to understand. Thanks Fred.
UNG is just not an interesting "investment" right now, and I still don't understand how Mr McLoed can be long UNG!
Gas producers and service industries might well be worth looking into in light of increasing industrial activities.

Sep 13 11:09 AM

[receipt:]

For true believers a very effective vehicle to go long natural gas is Horizons BetaPro NYMEX Natural Gas Bull Plus ETF (HZBBF) wherein, before expenses, the fund attempts to correspond to two times (200%) the daily performance of the New York Mercantile Exchange (NYMEX) natural gas futures contract for the next delivery month. This fund, based in Toronto, Canada, is managed by BetaPro Management Inc.

Sep 13 11:58 AM

[OldHead:]

Step back and try to take an unbiased look at this picture. Regardless of what anyone predicts or the short-term contango situation, common sense dictates being short at the bottom is a mistake. You may think we are not at the bottom. Well, look at the charts. Any lower and NG will be free. Winter is upon us and the price of NG will be going up.

I would certainly be a nervous Nellie if I were holding uncovered calls on this ETF. Actually, I would never, ever hold uncovered calls on anything. What if you're wrong? The sky's the limit on losses when playing with uncovered calls. Just my opinion.

Sep 13 12:16 PM

[aureus:]

Just a quick comment about HNU: Sitting long in HNU is a very risky business, which in a volatile environment - that is, without a clearly defined trend - is probably not compenseated by the possible reward.

Because: HNU gives you 2 times the daily movement in nat.gasprice. So If HNU falls ca. 30 % one day, and goes up ca. 30 % the next, you are not at break even - on the contrary, you are down ca. 10 %. So after a couple of volatile weeks, you may find that your account has diminished sustantially, whereas the nat. gas price still is about the same level as when you started ... quite irritating!

HNU is surely very exciting, but there are basically two ways to play it: Either you are daytrading, or - if you want to be long - you have to wait for a clearly defined trend in the gas prices.

Regards
Aureus


On Sep 13 11:58 AM receipt wrote:

> For true believers a very effective vehicle to go long natural gas
> is Horizons BetaPro NYMEX Natural Gas Bull Plus ETF (seekingalpha.com/symbo...)
> wherein, before expenses, the fund attempts to correspond to two
> times (200%) the daily performance of the New York Mercantile Exchange
> (seekingalpha.com/symbo...) natural gas futures contract
> for the next delivery month. This fund, based in Toronto, Canada,
> is managed by BetaPro Management Inc.

Sep 13 01:01 PM

[apppro:]

What I do find offensive are all these pundits who keep telling the rest of us what the real issues are and what we should or should not be investing in! I quote, "Unfortunately, buyers of UNG think they are buying Natural Gas,". Well, I'm a buyer and know damn well that I am not buying the actual gaseous substance. I realize that I have no room to store it in my apartment!
Who died and left all these so-called experts in charge of our well-being?

What I would like them to state is that they are short a financial instrument, and that anything they say will be in defense of destroying said instrument to promote their own financial gain.


On Sep 13 09:07 AM Fred Pollack wrote:

> On Friday UNG closed at $10.59, and its NAV was $9.12. In after hours,
> UNG said in an 8K filing that it would start creating new shares
> on September 28th. This will close the premium to NAV. In after hours
> trading, UNG stock was already off 50 cents.
>
> Unfortunately, buyers of UNG think they are buying Natural Gas, but
> they are really buying the near term futures. Usually, this is the
> same thing. The exception is when there is significant contango.
> And, now the contango is severe. The November futures are now priced
> $1.05 over the October futures ($4.01 vs. $2.96). From UNG's prospectus,
> over the next 4 days, starting Monday (September 14th), UNG will
> sell its October futures and buy November Futures. If you do the
> math, you will see that UNG will then own 25% less natural gas. Or
> stated differently, for UNG's NAV to remain the same over the next
> 4-5 weeks, spot prices of Natural Gas have to increase by ~$1.<br/>
>
> There are valid reasons for NatGas to get back to $5+. But the current
> storage situation suggests that this seems unlikely in the short
> term (next 1-2 months, if not a little longer). Unfortunately, neither
> UNG nor the futures make this easy. For example, the January futures
> are already priced at $5.06.
>
> To understand the dangers of investing in UNG, when there is severe
> contango, you need only read page 16 of the UNG prospectus (pg 22
> of the PDF download). You should read the 1/2 page on this, but here
> is just one sentence: "In the event of a prolonged period of contango,
> and absent the impact of rising or falling natural gas prices, this
> could have a significant negative impact on USNG’s NAV and total
> return."
>
> Disclosure: I have short position in UNG, via being short uncovered
> calls for Sep, Oct, and Jan.

Sep 13 02:49 PM

[taoshum:]

Well, I'm long for now and planning to keep the heat ON this winter and be thankful that the gas bill will be lower than last year but also hopeful that the gain on 500 shares of UNG (over the winter) will more than cover the heating cost for our house. Too simplistic, I know.

Sep 13 03:42 PM

[boisterousbob:]

Can the author, or anyone, please comment on how the price of natural gas is driven by the price of oil?

From a laymans perspective, and a beginning potential investor, the products seem to me to be non fungible. I can't burn oil in my kitchen to cook dinner. I can't put natural gas in my car. Why would a change in the price of one product affect the price of the other, when the products are not interchangeable or able to replace each other?

Sep 13 03:45 PM

[KonKreteishard:]

Long UNG, bot shares at $14, have been managing with short calls (covered) in combo with long puts (collar). Cost basis is $11.30. The volatility on the options is very high. They will issue new shares, later this month, not sure how much price will fall. Any thoughts on price reaction to the new shares being made available?

Sep 13 04:39 PM

[Northstar10000:]

Nat gas is such a no brainer if you have the stock and can ride it out.
buy in small chucks over the next 2 months. It is about the only low risk play in the market now.

Sep 13 05:04 PM

[Thomas MacLeod:]

Thanks for you question - It's a perfectly reasonable one.

There is no easy answer for that, but we'll try & give you a brief overview.

Oil, Gas, and Coal are the major energy providers for most economies. The price of oil is the most liquid and generally leads the business cycle, and hence prices.

Oil and Gas can be substituted, it just takes time. If oil hits around +USD100 then we suspect people may be converting their cars to run on natural gas. On your next visit to Sydney, Australia, have a look at the Taxis, they are all running on natural gas.


On Sep 13 03:45 PM boisterousbob wrote:

> Can the author, or anyone, please comment on how the price of natural
> gas is driven by the price of oil?
>
> From a laymans perspective, and a beginning potential investor, the
> products seem to me to be non fungible. I can't burn oil in my kitchen
> to cook dinner. I can't put natural gas in my car. Why would a change
> in the price of one product affect the price of the other, when the
> products are not interchangeable or able to replace each other?

Sep 13 09:23 PM

[boisterousbob:]

Apppro, I think you miss the point. Well maybe you don't need the warning but plenty of other people do. It isn't the fact that you aren't buying actual gas that is the issue. It is the monthly roll cost of a fund based on futures which show a deep contango. It would not be unreasonable for this fund to lose 10% a month if the price of gas does not move at all. A lot of people seem to need that warning even if you don't, because many people are surprised and dissappointed to lose money with this fund when gas doesn't move, or even a few per cent.


On Sep 13 02:49 PM apppro wrote:

> What I do find offensive are all these pundits who keep telling the
> rest of us what the real issues are and what we should or should
> not be investing in! I quote, "Unfortunately, buyers of UNG think
> they are buying Natural Gas,". Well, I'm a buyer and know damn well
> that I am not buying the actual gaseous substance. I realize that
> I have no room to store it in my apartment!
> Who died and left all these so-called experts in charge of our well-being?
>
>
> What I would like them to state is that they are short a financial
> instrument, and that anything they say will be in defense of destroying
> said instrument to promote their own financial gain.

Sep 15 08:58 AM

[boisterousbob:]

A lot of people seem to need that warning even if you don't, because many people are surprised and dissappointed to lose money with this fund when gas doesn't move, or even rises a few
per cent.

Added missing word "rises".

On Sep 15 08:58 AM boisterousbob wrote:

> Apppro, I think you miss the point. Well maybe you don't need the
> warning but plenty of other people do. It isn't the fact that you
> aren't buying actual gas that is the issue. It is the monthly roll
> cost of a fund based on futures which show a deep contango. It would
> not be unreasonable for this fund to lose 10% a month if the price
> of gas does not move at all. A lot of people seem to need that warning
> even if you don't, because many people are surprised and dissappointed
> to lose money with this fund when gas doesn't move, or even a few
> per cent.

Sep 15 08:59 AM