“I’ve been teasing a full write up on why I think the United States Natural Gas ETF (NYSE: UNG) may have been designed to lose money. If you’ve had the misfortune of owning this ETF, you are keenly aware of this tendency. In the past 9 months, the price of natural gas climbed off the floor of $2.75 per thousand cubic feet up to nearly $4.25 today. That’s a 55% gain. In that same time period, (NYSE:UNG) lost 27%. As a reminder, (NYSE:UNG) is NOT a double inverse ETF, but you wouldn’t know it from looking at those results. That brings me to crux of why this ETF does not perform the way you might expect it to, and how you can avoid making investments in similar ETFs that are more tar-pit than gold-mine. After all, the first rule of investing is “Don’t lose money.” Investors typically think of ETFs as baskets of equities, with performance naturally reflect the rise or fall of the value of those stocks. (NYSE:UNG) is structured a bit differently than other ETFs available to the public,” Kevin McElroy Reports From Wyatt Investment Research Reports.

According to the United States Natural Gas fund website:  “The investment objective of (NYSE:UNG) is for the changes in percentage terms of the units’ net asset value to reflect the changes in percentage terms of the price of natural gas delivered at the Henry Hub, Louisiana, as measured by the changes in the price of the futures contract on natural gas traded on the New York Mercantile Exchange that is the near month contract to expire, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire, less UNG’s expenses.”

Kevin McElroy  goes on to say, “In other words, the value of the fund is driven by front month natural gas futures exposure. To ensure continuous exposure, the fund’s administrators “roll” their front month futures contracts to the next month as expiration approaches to avoid taking physical delivery. Many ETF investors incorrectly assume that UNG attempts to track the return of natural gas spot prices – but this couldn’t be further from the truth.”

To explain this process further, I’ve enlisted the help of one of the best traders I know: Eric Adamowsky. Eric explains: ”The primary reason (NYSE:UNG) experiences such large losses EVEN when natural gas prices rise is the fact that the natural gas market is usually in contango. Contango is just a fancy word that describes a situation where the future prices of natural gas are higher than the spot prices. (NYSE:UNG) fund managers are forced to sell near month contracts (also known as “rolling” contracts) for less than the cost of back month, or second-month futures. This inevitably results in a loss of exposure to natural gas. The (NYSE:UNG) fund more or less pays a “premium” to roll the contracts to the next near month to avoid taking physical delivery.  Every time they buy the next front month and sell the current month natural gas future, they do so at a loss when prices are in contango – which they usually are!Contangoed markets are generally a result of higher storage costs, as in the case of natural gas which has extremely high storage costs. Higher future price expectations from market participants also cause a market to become contangoed Whereas a barrel of oil can sit in a barrel in perpetuity, if you want to store natural gas you need miles of pipeline and humongous high-tech gas storage tanks. It might be the most expensive commodity to store, so there are very few circumstances when it’s not in contango.”

“Furthermore, unless you can invent a way to store one thousand cubic feet of natural gas for free for the next 7 months, your storage costs will gobble up any price appreciation. That’s contango: natural gas costs more in the future, not because prices are going to necessarily go up – but because it’s expensive to store natural gas for any period of time. The longer you hold the contract, the more you’re paying for that storage. Natural prices could go up, and if you own the December contract you could certainly make some money, but prices would have to appreciate MORE than the current contango discrepancy of $1.25. Of course, I don’t advocate buying and rolling natural gas futures – but that’s exactly how (NYSE:UNG) is structured. For whatever reason, the fund is set up so that the ONLY way it can turn a profit is if prices are not in contango, that is, if front month prices are higher than subsequent month prices. It can happen, and when it does, it’s called backwardation, and it’s the result of unexpected supply and demand action in the market for natural gas. On the inverse, if the natural gas futures are in a state of backwardation, UNG may actually benefit from this condition. I don’t know about you, but I want to make money from the expected, not the unexpected,” Kevin McElroy Reports From Wyatt Investment Research Reports.

See more to Kevin McElroy’s article: HERE (Recommended)

Visit our Natural Gas Category For more analysis on (UNG): HERE 

We have listed some Natural Gas ETF options for investors to look at and compare to one another below.  Note that we have listed some industry related ETFs as well as direct Natural Gas exposure plays excluding any leveraged ETFs.        

United States Natural Gas Fund (NYSE:UNG)          

The United States Natural Gas Fund, LP (NYSE:UNG) is a new way for investors and hedgers to manage their exposure to energy. The United States Natural Gas Fund LP (NYSE: UNG) is an exchange traded security that is designed to track in percentage terms the movements of natural gas prices. UNG issues units that may be purchased and sold on the NYSE Arca. The investment objective of UNG is for the changes in percentage terms of the units’ net asset value to reflect the changes in percentage terms of the price of natural gas delivered at the Henry Hub, Louisiana, as measured by the changes in the price of the futures contract on natural gas traded on the New York Mercantile Exchange that is the near month contract to expire, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire, less UNG’s expenses.          

United States 12 Month Natural Gas (NYSE:UNL)          

The investment seeks to reflect the changes, net of expenses, of the spot price of natural gas delivered at the Henry Hub, Louisiana, as measured by the changes in the average of the prices of 12 futures contracts on natural gas traded on the NYMEX. The fund will consist of the near month contact to expire and the contracts for the following eleven months, for a total of 12 consecutive months contracts, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire and the contracts for the following eleven consecutive months.          

iPath DJ-UBS Natural Gas TR Sub-Idx ETN (NYSE:GAZ)          

The investment seeks results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones-UBS Natural Gas Total Return Sub-Index. The note is designed to reflect the performance of natural gas. The index is composed of the Henry Hub Natural Gas futures contract traded on the New York Mercantile Exchange.          

First Trust ISE-Revere Natural Gas Idx (NYSE:FCG)          

The investment seeks to replicate, net of expenses, the ISE-REVERE Natural Gas index. The fund invests at least 90% of assets in common stocks that comprise the index. The index is an equal-weighted index that consists of exchange-listed companies that derive a substantial portion of their revenue from the exploration and production of natural gas. The fund is nondiversified.          

iShares Dow Jones US Oil Equipment Index (NYSE:IEZ)          

The investment seeks results that correspond generally to the price and yield performance of the Dow Jones U.S. Select Oil Equipment & Servicesindex. The fund generally invests at least 90% of assets in securities of the Underlying index and depositary receipts representing securities of the Underlying index. It may invest the remainder of assets in securities not included in the Underlying index but which BGFA believes will help the fund track Underlying index, and in futures contracts, options on futures contracts, options and swaps as well as cash and cash equivalents, including shares of money market funds advised by BGFA. It is nondiversified.          

Jefferies | TR/J CRB Wildcatters Exploration & Production Equity ETF (NYSE:WCAT)          

The investment seeks investment results that replicate as closely as possible, before fees and expenses, the price and yield performance of the Thomson Reuters/Jefferies CRB Wildcatters Energy E&P Equity index. The fund normally invests at least 80% of total assets in the equity securities that comprise the underlying index and depositary receipts based on the securities in index. The index is designed to track the overall performance of a universe of listed U.S. and Canadian small and mid-capitalization companies engaged in the exploration and production of oil and natural gas. The fund is nondiversified.

Related posts:

1. How To Lose Money Investing In Commodities (GLD, UNG, USO, SLV, DBC)
2. U.S. Commodity Funds Files For United States Natural Gas Double Inverse Fund ETF (NYSE:UNGD)
3. Lose the Bunker Mentality Now (FXI, EWG)
4. Beyond The U.S. Natural Gas Fund: 3 Intruiging ETFs To Play Natural Gas (GASZ, UNG, GAZ, NAGS, CHK, DVN)
5. Natural Gas Prices: Why It’s Time To Load Up On Natural Gas (UNG, FCG, DVN, CHK, GAZ)

NYSE:GAZ, UNG