Carolyn Pairitz: Natural gas is one of the more volatile commodities, allowing investors to bring home serious gains, but also serious losses. It has become a trading favorite thanks to its violent price swings and its paradoxical habit of being consistently inconsistent. With weekly supply reports from the EIA as well as constant investor speculation over future energy uses, it is no surprise to see this asset class surge in such high popularity for the brave investor. But with natural gas futures being a bit too complex and dangerous for the average joe, many have turned to the United States Natural Gas Fund LP (NYSEARCA:UNG) for their exposure to this coveted trading asset [for more natural gas news and analysis subscribe to our free newsletter].
UNG is one of the most popular exchange traded products in the world; the fund holds over $1.2 billion in assets, 15 times larger than the next big competitor and an average daily volume topping 9.8 million. Unfortunately, this product comes with a significant amount of setbacks that have brought it under heavy fire over the last year. For starters, UNG passes along the nasty contango that natural gas contracts typically exhibit. As a refresher, contango is the process whereby near month futures are cheaper than those expiring further into the future, creating an upward sloping curve for future prices over time. When futures are contangoed, UNG’s monthly roll process forces it to sell low and buy high, erasing value for investors.
Also worth noting, UNG is an ETF, meaning it can exhibit tracking error as well as sending investors a K-1 form come tax time; something that many wish to avoid. Tracking error is the delta between the performance of an ETF and the change in the underlying index, meaning that UNG will not always trade in line with the futures it tracks. On top of all of that, UNG is prone to some horrendous performances, making it a rather risky product. But given all of its shortcomings, this product still remains in the spotlight, especially now with NG making a rebound. For investors who are fed up with UNG’s unreliable returns or those who simply want a potentially better way to play natural gas, we outline three alternatives below [see also The Rise and Demise of UNG]:
E-TRACS Natural Gas Futures Contango ETN (NYSEARCA:GASZ)
This ETN, which will not incur tracking error or distribute a K-1, puts a unique spin on natural gas investing. In an attempt to battle contango, GASZ shorts the near month natural gas contracts while establishing a long position in mid-term futures. This strategy profits off of the roll process that typically loses value for an ETF and makes for a product that can actually be held in a longer term compared other futures-based funds. With $11.1 million in assets, this product is less volatile but trades only 7,400 shares a day. Note that the unique exposure comes at a price of 85 basis points compared to the 60 that UNG charges.
|Natural Gas ETFs|
|Data from 10/17/2012|
ISE-Revere Natural Gas Index Fund (NYSEARCA:FCG)
Investors looking to avoid complicated futures contracts and contango risk all together should consider this equity-based natural gas ETF. With exposure to over 30 companies whose main source of income derives from exploration and production of natural gas, this often overlooked ETF can be held over a longer time and requires less attention then futures-based ETPs. With an expense ratio of only 0.6% and the added bonus of a 0.5% annual dividend yield, it’s a surprise that FCG trades only half a million shares a day[see also Five ETFs to Ride the Natural Gas Rally].
Natural Gas Fund (NYSEARCA:NAGS)
This young fund from Teucrium stands out from its competition. For starters, investors will notice that it charges 150 basis points, extremely high by ETF standards. But a closer look at this ETF and its underlying performance may draw some in, as the product’s strategy gives it the potential to outpace its competition. NAGS differentiates itself by aiming to reflect the daily changes in percentage terms of a weighted average of the following: the nearest to spot month March, April, October, and November Henry Hub Natural Gas Futures Contracts traded on the NYMEX, weighted 25% equally in each contract month. That structure is utilized in an effort to reduce the effects of contango and backwardation on fund returns.
Written By Carolyn Pairitz From CommodityHQ Disclosure: No Positions.
CommodityHQ offers educational content, analysis, and commentary on global commodity markets. Whether you’re looking to speculate on a short-term jump in crude or establish a long-term allocation to natural resources, CommodityHQ has the information you need.