Natural Gas Bears Now In Full Retreat

Includes: GASZ, UNG
by: Kenneth D. Worth

After a dismal start to the year, the United States Natural Gas ETF (NYSEARCA:UNG) has shown solid strength over the past three weeks as the front month contracts have outperformed the longer dated contracts and natural gas prices have surged.

As argued in my April 26, 2012 article, Natural Gas Has Nowhere to Go But Up, natural gas selling for less than $2 per MMbtu in an era of hydraulic fracturing was clearly unsustainable and exhibited all the classic signs of a market bottom. It is now becoming more and more clear that April 19-20, 2012, was likely the end of a long-term bear market for this volatile commodity.

As the underlying commodity has rallied, UNG has risen to a high around $18 today compared to its April 19 closing price of $14.25 (up 26.3%, see above chart.)

The rebound in gas prices has been led by the front month contracts. Contango, which was quite severe during the selloff has been shrinking notably. This can be seen in the performance of UBS ETRACS Natural Gas Futures Contango ETN (NYSEARCA:GASZ), an ETN that represents a play on contango in the natural gas market by taking short positions in the near-term delivery months and long positions in more distant delivery months.

GASZ has fallen from 32.10 on April 19, 2012 to around 30.31 at the time of this writing on May 11, 2012. This decline of roughly 5.6% indicates that the near-term contracts are significantly outperforming the longer dated contracts.

Investors seeking to avoid contango by buying futures in more distant months have thus not participated in the full extent of the natural gas rally. Should natural gas continue to rally across the delivery time-spectrum, the near-term months could very well continue to outperform. This would mean that near-term month natural gas ETF's such as UNG will finally provide some benefit other than to those on the short side of the trade. GASZ, meanwhile, could very well continue to fall.

Yes, the contango is still steep, with the June contract trading at $2.51 per MMbtu while the December is significantly higher at $3.36. Nonetheless, if the natural gas rally continues in full force over the next several months, and contango continues to lessen in severity, near-term futures contracts and near-term ETFs such as UNG will very likely offer the highest rewards to net long traders.

Disclosure: I am long UNG.