Eric Dutram: As the economy is recovering gradually in 2013, economic activity has started to pick up across the country. Yet, some significant headwinds could upset the potential recovery before it manages to pick up steam, specifically, the impact of high gas prices.
This surge in prices has been brought about by a few key factors. First, the price of crude is climbing as the global equity indices is hitting the new 52 week high and Euro zone is showing some signs of improvement.
Additionally, the closure and maintenance of refineries on the East and West Coasts will likely curtail gasoline supplies. Beyond that, gasoline demand is also on the rise owing to improving job markets and recovering economic fundamentals (read: 3 Energy ETFs for America’s Production Boom).
Investors could easily take advantage of this trend by focusing on broad energy ETFs. While all energy products have been performing well this year, the real winner has been in the world of gasoline, as represented by the United States Gasoline Fund (NYSEARCA:UGA).
UGA in Focus
UGA allows investors to directly make a play on the commodity of RBOB gasoline and provides a vehicle to hedge gasoline movements or to take directional positions on gasoline prices (see more ETFs in the Zacks ETF Center).
The fund tracks the changes in percentage terms of its units’ net asset value to reflect the changes in percentage terms of the price of gasoline. This is measured by the changes in the price of the futures contract on unleaded gasoline traded on the NYMEX that is the near month to expire, except when the near month is within two weeks of expiration. When that is the case, the next month’s contract will be used instead.
The ETF is less liquid with daily trading volume of about 36,000, suggesting a wider bid-ask spread. As such, investors have to pay extra beyond the annual fee of 60 bps in fees per year. The fund has managed assets of $70.1 million so far.
The fund easily outperformed the other oil-based ETFs in the segment, gaining about 9.6% year-to-date compared to 5.9% gain for both Brent Oil (NYSEARCA:BNO) and WTI crude, as represented by (NYSEARCA:USO). In fact, UGA also outpaced the broad market fund (NYSEARCA:SPY) by 340 bps so far in the year (read: Venezuela: The Next Black Swan for Oil ETFs?).
While generating solid returns, UGA can be susceptible to roll yield. Roll yield is the positive or negative return that occurs when a futures index or ETF rolls from the near month’s contract to the next month’s contract.
The roll yield is positive when the futures market is in backwardation and negative when the futures market is in contango. Basically, if the price of the near month contract is higher than the next month futures contract, then this is backwardation.
State of Backwardation on UGA
UGA is poised to benefit from the prolonged period of backwardation. Currently, the gasoline market is in backwardation which is bullish for the commodity and the gasoline ETF UGA.
Hence, the fund rolls over the next month futures contracts at a lower price, thereby making profits. A market in backwardation signifies that demand exceeds supply boosting gasoline prices higher (read: Why the Gasoline ETF Is a Top Performer).
Given that gasoline prices seem to be on the rise with supply/demand imbalances and the economy appears to be on the mend, UGA could be an interesting pick for investors looking to make a concentrated play on the gasoline segment of the energy market.