Have The Natural Gas ETFs Finally Bottomed Out?

by: Zacks Investment Research

Although many energy commodities are surging, natural gas is still feeling the pain of weak prices. The commodity remains under pressure as new supplies of the key fuel are brought online all the time, making the historic oversupply situation even more of an issue. It also hasn’t helped that the winter has been unseasonably warm across much of the nation, reducing demand for the product as a key input for power plants as well.

These trends have pushed some more intrepid investors to predict a bottom in natural gas prices, declaring that eventually, this rough bear market in prices, which has seen the value of front month natural gas contracts decline from about $12/mm BTU in 2008 down to its current price around the $2.5 mark, has to end. Yet while investors continually call for the bottom in natural gas prices, the key commodity just keeps falling. In fact, prices have fallen by 50% in the past one year period and they are now near a 10 year low while inventories look to approach the highest winter close since 1983 when they hit 2.1 trillion cubic feet (read Commodity ETFs Plunge On Supply Forecast).

As a result of this, the outlook for natural gas still looks shaky going forward, especially given broad uncertainty over CNG and LNG implementation on a large scale. With this overhang, natural gas may not have reached a bottom just yet, especially if more gas supplies are brought online or if weather remains unfavorable to demand. On the other hand, a supply shock—be it in the form of weather or regulation—coupled with increased demand from new gas uses could make some investors look back on this time as the moment to buy (read Three ETFs For An Iranian Crisis).

While no one knows for sure which path will be the case, at least investors still have a plethora of options to play the fuel. Below, we highlight some of the pros and cons of each approach as well as a brief discussion of what investors can expect to see in each of these natural gas ETFs:

Natural Gas Futures ETFs

For investors seeking direct exposure to natural gas prices, the United States Natural Gas Fund (NYSEARCA:UNG) will be tough to beat. The fund sees volume of close to four million shares a day and has AUM of nearly $900 million, suggesting tight bid ask spreads for the product. However, the fund has seen heavy contango in recent months and years, coupled with the general decline in value of natural gas prices. Thanks to this, UNG has lost about 52% over the past 52 weeks including more than one-third of its value in the past three months alone (see Inside The Forgotten Energy ETFs).

Beyond UNG, there are a number of other options as well, including the fund’s cousin the United States 12 Month Natural Gas Fund (UNL). This product sees slightly less in contango thanks to its approach which spreads out exposure across 12 months of the curve, helping to push the fund down ‘just’ 42.5% over the past 52 weeks, although it does see tiny volumes in comparison. In addition to this choice, investors also have the iPath DJ-UBS Natural Gas TR Sub Index ETN (GAZ) for those seeking the ETN structure, Teucrium’s Natural Gas Fund (NAGS) which spreads out exposure across multiple points on the curve, and the iPath Seasonal Natural Gas ETN (DCNG) which only offers exposure to December contracts.

Natural Gas Equity ETFs

Given the uncertain future of the commodity, as well as recent price weakness, some investors may want to play natural gas via an equity route instead. This path may see less volatility than commodities, and also help to avoid the contango issue too. On this front, investors currently have two options; the First Trust ISE Revere Natural Gas Index Fund (FCG) and the brand new Market Vectors Unconventional Oil & Gas ETF (FRAK).

FCG holds 30 securities in total, charging investors 60 basis points a year for access to its basket of natural gas focused stocks. The product has a heavy focus on exploration and production firms as these securities make up nearly 80% of the total exposure. From a performance perspective, the fund is down just 14% over the past year but is up 6.6% in the past quarter. FRAK on the other hand could see some of same key risk/reward points as FCG but could also see a heavy influence from the oil shale market as well. Still, the product has a similar 80% focus on energy exploration companies so it could be another way to play the natural gas market (read Is HAP The Best Commodity Producer ETF?).

Short Natural Gas ETN

Given the oversupply situation and the lack of new uses for large amounts of natural gas at this time, some may want to take a short position in natural gas. Until recently, this was tough to do with ETPs but appears to have changed with the launch of the VelocityShares 3x Inverse Natural Gas ETN (DGAZ). The note looks to provide triple the daily inverse performance of natural gas futures while collateralizing the investment with a purchase of short-term Treasury bills. This could make DGAZ a great pick for those who think that the oversupply situation in the natural gas market has further to run and that prices of the important fuel are headed sharply lower again this year.