Why The Natural Gas ETN Is Broken

May. 3.12 | About: iPath DJ-UBS (GAZ)

by Richard Rittorno

Would you take this trade? Trader Kip is selling a gallon of gasoline for $10.00. His asking price is trading at a premium of more than 100% to the indicative value of $4.00. If you said no – you took the smart course of action. If you are unsure what indicative value means, below is a quick definition:

Indicative value is the measurement of the intraday net asset value or NAV of an ETF or ETN. The indicative value is calculated throughout the day and provides the trade in which to measure the value of an investment based on its assets less its liabilities. The asset NAV is typically calculated at the end of the trading day; however, the indicative NAV measure gives a more real-time view of this value through the day, sometimes referred to as indicative value.

Now ask yourself; would you trade an exchange traded note indexed to natural gas futures that has been and is trading at more than 100% of indicative value? This means you would be paying more than the value of natural gas on the futures market. This position, from the moment you purchased the ETN, would be setting you up for potential losses regardless of the movement of the actual commodity’s price.

It is so important that traders and investors truly understand what they are buying. As we’ve pointed out along with every other news service, natural gas has been in a free fall until recent weeks as traders attempt to catch the bottom.

Many traders will use ETFs and ETNs to gain access to the futures market within the equities market. However, most deliverable commodity ETFs/ETNs have a fundamental flaw due to their construction.

That fundamental flaw can reach extremes when a commodity is trading at extremes, and now the price per share of GAZ is more than double its indicative value. To make matters even worse for the ETN, the issuer for GAZ - Barclays - suspended new share issuance back in 2009.

Bottom Line: When an ETF or ETN halts new share issuance, the trading vehicle can be subjected to factors other than the movement of the market the ETF or ETN tracks. Broken ETFs or ETNs are not like broken stocks. When they break, run for the hills.