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Since its launch in April 2007. the United States Natural Gas Fund (NYSEARCA:UNG) has endured a strange existence. After enjoying moderate success during its first 18 months–assets stood at more than $700 million at the end of 2008, UNG exploded as the natural gas craze hit and investors lined up for access to the “fuel of the future.” Cash inflows in 2009 topped $5.5 billion, fewer than only three other ETFs. UNG quickly became the third largest exchange-traded commodity product (behind only GLD and SLV) and famously spurred a series of meetings among regulators over the role of ETFs in commodity markets.

But in recent months the ultra-popular natural gas ETF has sprung a leak. At the end of March, UNG had assets of just over $2.8 billion, down from $4.6 billion at the end of 2009. The bulk of this decline is attributable to ongoing weakness in natural gas fundamentals; prices are already down about 30% on the year (see How UNG Lost 20% In March). But poor share performance didn’t keep investors away in 2009, when UNG’s price slid by 50% but assets increased more than fivefold.

UNG: Now And Then

12/31/09 3/31/10
Assets $4.6 billion $2.8 billion
3 Month Inflows/(Outflows) $991 million ($430 million)
ETF Size Rank (Total/Commodity) 35/3 62/4

The downward slide in market value has continued in 2010, but there hasn’t been a wave of cash inflows to offset losses. According to the latest data from the National Stock Exchange, UNG saw net cash outflows of $430 million in the first quarter of the year, including more than $400 million in February (January was cash flow neutral while March saw $24 million in outflows). After the double whammy of plunging natural gas prices and three months of cash outflows, UNG’s assets have shrunk by 40%. After finishing 2009 as the 35th largest U.S.-listed ETF, UNG is now smaller than more than 60 funds.

What’s Driving The Collapse?

So what’s to blame for the loss of interest in the seemingly invincible UNG? It’s impossible to say for sure, but there are likely a number of contributing factors. The regulatory environment remains uncertain, although UNG’s shrinking act has addressed some of the concerns that attracted regulatory scrutiny in the first place.

There’s some evidence to suggest that investors bullish on the price of natural gas are turning towards other ETFs to achieve their exposure, but several of UNG’s most direct competitors have also seen a drop in interest. iPath’s Natural Gas ETN (NYSEARCA:GAZ) hasn’t seen much in the way of inflows (or outflows) this year. The United States 12 Month Natural Gas Fund (NYSEARCA:UNL), which holds futures contracts expiring at 12 different dates, saw modest inflows of $4 million in March. Because UNL rolls only a small portion of its holdings each month, it is generally less responsive to changes in spot prices but also less likely to see its returns eroded by contango.

Another popular alternative to UNG is the First Trust ISE Revere Natural Gas Fund (NYSEARCA:FCG), an equity ETF that seeks to replicate the performance of the ISE-Revere Natural Gas Index. This benchmark consists of companies that derive a substantial portion of their revenues from the exploration and production of natural gas, and considers correlation to gas futures prices when evaluating candidate stocks. FCG has become a popular choice–assets exceed $450 million and average daily volume tops 700,000–but didn’t see much growth in the first quarter of 2010. After $13 million in outflows in March, this fund is also in the red on the year.

Part of the drop in UNG’s asset levels may be attributable to a shift away from futures-based investment strategies. Although ETFs investing in futures contracts tend to exhibit a very strong correlation to spot prices, they don’t always match the performance of spot prices exactly. UNG demonstrated this phenomenon in 2009, as natural gas spot prices finished the year about where they began but shares of the fund lost half their value. As investors became familiar with the nuances of a futures-based strategy, some have elected to achieve commodity exposure elsewhere. The United States Oil Fund (NYSEARCA:USO), which uses futures to track movements in the price of crude oil, has seen more than $900 million in outflows in the first quarter.

But perhaps the biggest driver behind UNG’s steady decline is just a drop in interest in natural gas as an investable asset. When prices sunk in 2009, investors pointed to the historical relationship between crude oil and natural gas as evidence that a rebound was inevitable. But as massive new discoveries continue to be made and technological advancements continue to boost supplies, a recovery in natural gas prices is no longer a given. Moreover, the volatility of natural gas–daily swings in UNG of 2% or more are fairly common–may be more than some investors can stomach.

Broad-based commodity ETFs such as DBC and DJP have grown in 2010, suggesting that interest in commodities as an asset class remains. But interest in natural gas exposure–at least that achieved through futures contracts–is clearly on the decline.

Impact On USCF

The significant decline in assets translates to a big financial swing for U.S. Commodity Funds. UNG charges a management expense ratio of 0.97%, meaning that the fund went from generating $45 million annually in revenue to a run rate of about $27 million in only three months. That’s still a nice chunk of change, but it’s never fun to lose $18 million in annual revenues.

Disclosure: No positions at time of writing.

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Source: The U.S. Natural Gas ETF Springs a Leak