(Natural) Gas Pains?

June 22, 2009

Investors are flocking to the UNG natural gas ETF just as natural gas prices are falling. What's going on?

  • Crazy volumes
  • Killer contango
  • The 6-month weather forecast?

 

Has the U.S. Natural Gas ETF (NYSE Arca: UNG) gotten almost too big for its britches? The fund, which began trading two years ago, has generated so much interest that it has had to ask the SEC for permission to expand, not once, but twice since the beginning of the year. As you'd expect with any growing ETF, trading volumes have also skyrocketed. But the timing seems odd, if you check out the chart, as interest seems to have increased in the fund after the price of natural gas dropped last summer. Now we're in a period of low natural gas prices and interest has skyrocketed.

 

UNG: The Price and Volume Story

 

Why is it so popular? Is its current popularity a result of all of the media attention? Because, lord knows, it's not the most recent returns that are fueling the fires:

 

UNG Performance From Feb to June 15 2009

 

Since the beginning of the year, UNG has had a negative 34.4% return. Between falling natural gas prices (around $6 at the beginning of the year to sitting around the $4 mark currently) and steep contango, ETF investors just haven't stood a chance.

For those sleeping during finance class, contango is when distant contracts are more expensive than near-month contracts. When futures are in contango, the simple act of rolling into the next contract loses you money. Since ETFs, and most commodity investors, aren't interested in taking delivery of 10,000 mmBtu of natural gas, rolling contracts forward is just a fact of life. Right now the contango is steep - take a look at a snapshot from Friday:

 

July '09 4.085
Aug '09 4.254
Sep '09 4.376
Oct '09 4.569
Nov '09 5.221
Dec '09 5.893
Jan '10 6.190
Jul '10 6.275
Jan '11 7.470

 

The difference between July and January 2010 is a 51.5% increase. Crude oil contracts in the same months show only a 5.8% difference. Another way of thinking about it is that just rolling from July to August would cost you over 4%. Do that every month for a year, and that's a huge headwind.

 

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