U.S. Natural Gas Fund: The Beginning of the ETF Unwinding?

In my blog posting on July 3, 2009 titled "ETF: Mediocrity with No Pretense of Value," I said:

"The structure of a scheme like this [ETFs] only works when the market continues higher or new money floods in."

Are we on the cusp of seeing this situation with EFTs unravel? Currently, the U.S. Natural Gas Fund (UNG) is being forced into the position of issuing new shares to offset the expiration of old creation units. Without the issuance of new units, UNG has become priced well above net asset value ((NAV)) as new money has flooded in with a diminishing number of units.

Some have said that the real problem is the fact that UNG has been too successful at raising money. I believe that the flood of money into the fund shouldn't be considered a success, instead it should be considered bordering on a Ponzi or pyramid scheme. Again, no value exists unless more money comes into the fund. If the spigot of new money was turned off, in a matter of months the fund would end up worthless, unless the price of natural gas goes up.

One guy, Jim Cramer, said back in June that he believed that the flood of money into the ETF would actually allow UNG to push up or prop the price of natural gas. However, when you view the history of natural gas prices over the last year (courtesy James L. Williams of WTRG Economics at WTRG.com) you can easily see that, in this case, UNG and the futures price of natural gas are in complete agreement.

Most market professionals would claim that a changing of the rules is the real reason why there is turmoil in the commodity ETF market which is reminiscent of the FIRREA rule change on Savings and Loan institutions before the S&L crisis. The reality is that the rule changes are an outgrowth of lawsuits from overzealous attorneys on behalf of misinformed investors. In their zeal to create hedging and leveraging opportunities to the retail investors, leveraged ETF distributors didn't emphasis enough the fact that the risk of loss was far beyond known market risk. Unfortunately, like the FIRREA rule change we could see painful unintended consequences.

Oh, by the way, did I mention that there is no real intrinct value to ETF funds? Whether they are Index ETFs or leveraged ETFs it is really all about the luck of the draw. If a lot of money is coming in at the time that you own the fund then the NAV will move in-line with the market. However, when net redemptions exceed new money coming in, the value of the ETF declines. The only hope is that the market an ETF fund is in a rising trend.

The news on UNG's plight isn't all that encouraging even though the issuance of more shares is meant to mitigate the disparity in the NAV. My hope is that things don't get to out of hand as we enter the most volatile months in the year. Touc.

The following are the latest articles on what may become the great ETF unwind.

• CFTC Position Claims First ETP Victim
• Regulatory Storm Brews for ETFs
• Leveraged ETFs: Desperate Times
• CFTC Speculation Rules Hit $10 Billion in ETFs, ETNs
• FINRA, SEC Warn Retail Investors About Investing in Leverage or Inverse ETFs

Disclosure: No Positions

Comments

[Mad Hedge F...:]

uuut. 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 06:43 AM

[apppro:]

Mad, what do you do - copy and paste the same blog on every article for NG? At least on the Yahoo message boards they don't allow this kind of blatant spamming.




On Sep 13 06:43 AM Mad Hedge Fund Trader wrote:

> uuut. 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 08:21 AM

[stocknerd:]

Money will come into UNG as soon as the price of NG rises. These times have seen the rapid fall (historic) of NG because of demand and supply have both worked against the the PPS. All things can't go one direction forever, markets correct themselves. Sure ETF is a scheme, the stock market is a scheme.

Sep 13 08:32 AM

[apppro:]

While most, if not all investors know what the VIX is – how can you not by the constant CNBS shoving it down our throats. – most do NOT know that you can now TRADE the VIX through options.
Now that makes sense! Let’s trade the indicator of ‘volatility’ by use of the very volatile instruments it was meant to measure, SO>>>> the more volatility the VIX shows the more VIX’s options trading will occur creating more volatility, SO>>>> the VIX will have to rise in order to reflect that volatility and SO>>>>> the volatility in the VIX options will rise and so on and so on and… you get the picture.

THIS IS INSANITY!!!!!!!!



On Sep 13 04:27 PM BAHRAIN CONNECTED wrote:

> SECRET THAT YOU WILL NEVER KNOW EVEN IF YOU DIE FOR IT (chart in
> instablog)
>
> All of you know what is VIX ( S&P 500 1 month expected volatility
> ) but none of you knows what was the VIX high in the last 100 years.
> This chart shows VIX during last decade that included Asian crisis,
> Russian debt default, South America crisis, Turkish Lira devaluation,
> Nasdaq bubble, September 11, 2001 and even 2008 market panic. Now,
> before I will tell you the secret, I ask you to take your time, do
> your own research and write on my website in the message or chat,
> what is the highest number you came upon. You can even count from
> 1929 if you want (this requires different matrice calculation, but
> 1929 didn't had the higher VIX what you can see from this chart,
> because VIX is derived from ATR average true range, which was no
> bigger than during other stock market crashes).
> Only few people know what was the highest historical VIX, I am one
> of them.
> From this chart the important levels are 21.17, 13.09, 54.87 and
> 90.06.
> Most institutional investors traded by this levels and bought stocks
> when DJIA was 6600 and VIX aroud 90, for the wrong reason and they
> are going to lose everything. I will share this secret only with
> traders who will submit their high VIX variation on my website. Good
> luck, split timing started.
>

Sep 13 04:43 PM

[Indexor:]

Looking at the VIX...

On a closing price basis, VIX hit a high last year of 80.86 on November 11, 2008 (which was also its intraday high). Prior to that, going back through the year 2000, the high had been 45.08 on August 5, 2002 (also its intraday high). The closing low was 9.97 reached on December 14, 2006, although intraday it hit 9.64 the same day.

On March 9, 2008 "when DJIA was 6600" the VIX closed at 49.86, substantially less than "VIX around 90." Somehow I do not believe anyone would care to "die for" any additional information on the VIX as it does not appear to be a statistically important leading indicator of DJIA bottoms or tops.

Sep 13 05:36 PM

[veritas666:]

u are a moron!

Sep 14 12:42 AM