Natural Gas ETFs In Focus As The Gains Continue

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April 22, 2013 12:16pm NYSE:DGAZ NYSE:FCG

natural-gas-runupFor investors focused in on commodities, 2013 has been a year to forget. A variety of products in both the precious metal and energy segments have seen severe weakness to start the time frame.

Among the issues plaguing the space are concerns over global growth, and an increasingly firm dollar. Both of these trends are keepinga lid on a host of natural resources, while many investors are forecasting these factors to be in the market for quite some time.

Yet despite the broad gloom over the commodity market, investors have seen a glimmer of hope in an unlikely place; natural gas. The often beaten down commodity has seen a great start to the year, gaining over 25% while other commodities stumbled into the red.

This represents a huge reversal for natural gas, as the commodity has been under severe pressure in years past thanks to a huge supply and demand imbalance. But due to some rig shutdowns and more power plant use of the fuel, natural gas is coming back strong in 2013.

This trend has continued with the latest EIA storage report, as this release suggested more bullishness in the important energy commodity. The consensus expectation called for an increase in natural gas stocks of 35 billion cubic feet (bcf) but just 31 bcf were added to inventories instead, boosting front month futures by over 5%.

So even though this marked the first increase in natural gas stocks since December 2012, the lower-than-expected increase was seen as another reason to be bullish on natural gas in the near term. Many are expecting this trend to continue as well, as colder-than-normal temperatures in much of the Midwest and Northeast could keep a cap on supply increases in the weeks ahead.

Natural Gas ETFs in Focus

This latest EIA release was also great news for the wide range of natural gas ETFs that are in the market, as they also benefited from the bullish tone in the space. Topping the list in terms of volume was the United States Natural Gas Fund (NYSEARCA:UNG) which finished the day up about 5%.

This came on volume that was roughly 170% of normal, largely thanks to a couple of volume spikes immediately following the release of the crucial EIA report. Once this document was released, UNG did about 20% of its usual daily volume in two minutes, a situation that pushed the commodity fund sharply higher as well (see Behind the Surge in Natural Gas ETFs).

Beyond UNG, investors also saw a good session out of the United States 12 Month Natural Gas Fund (NYSEARCA:UNL) . This product seeks to spread out exposure across the futures curve in order to mitigate contango issues, a problem that has been a big issue in the natural gas ETF market.

However, during bullish market environments, like the recent one, this ends up hurting the return when compared to UNG. For example, UNL was only up about 3.6% after the report was released, while the fund has underperformed its more popular counterpart by about 500 basis points in this calendar year, although it has done much better over long time periods.

Leveraged options for natural gas

For investors with a big appetite for risk, there are also a few somewhat popular levered natural gas products in the market from VelocityShares and ProShares.

ProShares reigns over the double leverage segment with its daily -2x bearish product KOLD, and its 2x bull daily product BOIL. Respectively, these two saw performances of -9.6% and 9.6% on the session (read the Comprehensive Guide to Natural Gas ETFs).

Meanwhile, VelocityShares takes care of the triple leverage market with its (NYSEARCA:DGAZ) for bearish daily exposure and (NYSEARCA:UGAZ) for bullish 3x exposure. As expected, these two were extremely big movers on the day with DGAZ slumping by –14.6% and UGAZ surging by 14.9% in Thursday trading.

Equity play on Natural Gas

For those that are scared off by UNG’s long term performance or the risky nature of leveraged ETFs, it is worth noting that there is an equity play out there that targets the broad natural gas market in ETF form. This fund is the First Trust ISE Revere Natural Gas Index Fund (NYSEARCA:FCG) , an ETF that holds about 30 stocks in its basket and charges investors 60 basis points a year in fees.

The fund hasn’t kept up with UNG so far in 2013—it is roughly flat on the year—but that shouldn’t be too surprising to investors. After all, a big chunk of natural gas’ rise as of late has been due to lower production levels, a factor that helps to boost prices but can shrink revenues for some in the industry.

Additionally, the benchmark does include a number of exploration companies, so these have been under pressure thanks to the heavy competition in the market. The product also includes a fairly big allocation to micro and small cap companies, so volatility can be an issue.

Still, FCG doesn’t suffer the contango (or backwardation) worries that are inherent in natural gas ETFs like UNG. This makes FCG a more stable play on the market, but one that may not benefit from trends like some investors might be expecting (also read Time to Sell This Commodity ETF?).

Bottom Line

There are a number of options out there that target natural gas in ETF form, both in the form of equities and especially in terms of futures on the commodity. For much of 2012, these had been terrible picks for investors and many assumed that this trend would continue this year as well.

This is especially true given the broad slump in the commodity market, as almost every product has been hit by the trend, including traditional safe havens like gold. However, natural gas has escaped this spiral, and thanks to some favorable supply trends, has actually surged so far in 2013.

So while natural gas is still a very risky pick in the near term, it is no longer the sure loser that it once was. The supply and demand imbalance is beginning to shrink, while more are using natural gas all the time.

This has helped natural gas have a more favorable futures curve, suggesting that we could see some more solid days ahead for volatile natural gas ETFs in the weeks ahead. Particularly if cold weather and below-expectations supply increases continue in this outperforming corner of the ETF world.

This article is brought to you courtesy of Eric Dutram From Zacks.

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