I read an interesting post at The Disciplined Investor on the Natural Gas ETF UNG.

If you bought the “natural gas” fund assuming that it would follow the commodity’s performance you would be wrong. Since last September, in fact, UNG underperformed significantly the spot price of the commodity. This is because it follows the percentage change in the price of the commodity’s front month contract. The problem is the market is in contango. In this situation longer-term contracts are priced higher than near-term contracts and the fund will underperform the underlying commodity. The result is quite impressive and disappointing (for some at least).

I have no idea why the divergence in behavior started in September and why there is such a wide contango in gas. The post proposes two scenarios. One where "UNG will come back in line with the natural gas pricing when (if) there is a the contango spread reduces to historic levels". The second where as the fund is "too big and because futures roll every month, there is no way that this can ever catch up".

Quite interesting example of product "inefficiency".

George Parkanyi writes:

I’ve been trading in Canada a similar ETF called Horizons BetaPro Natural Gas Bull+ ETF (TSX:HNU) – a double-long ETF. That’s also been in an abysmal bear market, having completely imploded after the commodities collapse in the second half of 2008. If you’re buying and holding a double long or short ETF (much worse for the short ones), a long one-way move against pretty-much wipes out the value and you will never recover if you bought at the higher end. However, for an active shorter-term trading strategy, you can still get very good moves out of these. HNU rallied from about $8 to $17 in September and October just recently. That’s a pretty good move if you can catch it. (Although its back down around $9 again now.)

You are right about the contango. As soon as they roll into the front month, it immediately goes down. Keep doing that every month… I have a large gas weighting in my portfolio and that’s my main concern as well.





Speak your mind

5 Comments so far

  1. michael bonderer on November 24, 2009 12:53 pm

    No storage therefore production slowing markedly. I direct all speculators to the quarterly conference of EOG Resources (EOG) (the diamond-in-the-rough of the Enron debacle), the preeminent nat gas independent and its Chairman and CEO, Mark Papa’s ‘gas macro’ comments. Always quite illuminating.

  2. paolo pezzutti on November 24, 2009 2:40 pm

    sorry but I could not find the gas macro comments

  3. michael bonderer on November 24, 2009 3:04 pm

    hi, you have to go to their web site and then go to archived quarterly conference calls and as part of management’s presentation and analyst Q&A you will hear Papa’s “gas macro” commentary, and analyst follow-up questions re “gas macro”. you have to listen to the taped archive. each quarter he updates his perception of “gas macro” based on EOG’s experience in the field and what he and they see. there is no better growere ‘through-the-drill-bit’ then them. one of the leaders in horizontel drilling and shale ‘fracing’ and now pioneering horizontel drilling tech and fracing to the oil mrkt. very savvy guys.

  4. Jon Margolis on November 25, 2009 11:30 am

    This is a misleading concept since storage costs and convenience yield will never allow the same return to an investor (whether an ETF or someone buying front month futures and continuing to roll), as a front month future actually has, since the percent return for the front month future wont pay down storage costs. So when there is extreme contango this is magnified. Back in late summer and early fall when there was a double digit premium from second month to front month, if you looked at the returns of the front month future over those months it would gain that, but an investor in front month futures would lose it as he rolls. Same thing for UNG or any other ETF that buys futures and rolls.

  5. Paolo Pezzutti on November 27, 2009 6:43 am

    Donald Coxe, of Coxe Advisors LLC, discussed the outlook for Natural Gas, Shale Gas, and the controversial accounting of natural gas reserves.
    Following are some interesting points:
    - Natural gas spot prices are sensitive to changes in climate
    - The March futures contract is a good indicator of trending because March comes after the 3 coldest months of the year.
    - Historically Oil and Gas traded with good correlation, but Shale Gas horizontal drilling technology has smashed the price of natural gas relative to crude oil. Technology is having a profound effect on price and supply.
    - Accounting rules allow Integrated Oil and Gas firms to post proven gas reserves as a component of Reserve Life Index - 6 MCF of Natural Gas = 1 bbl. of crude oil, leading to “overstatements” of RLI.
    - Lack of sunspot activity could mean a cold winter.
    - Russia dominance in oil and gas is challenged by Exxon’s discovered gas in Germany.
    - Europeans, concerned that Russia could shut off gas to the Ukraine, started to seek different arrangements.
    - Technology has made it possible to extract natural gas profitably at $4.50 MCF and that means there is a price cap at that level.


Resources & Links