Will UNG Be the First Big ETF to Go Bust?
The poster boy for everything that can go wrong with an ETF is undoubtedly the United States Natural Gas Fund (UNG). If you had studiously done all of your homework in September and concluded that
natural gas was severely oversold and about to go up 40%, you would have
been dead right. If you then went out and bought the UNG you would have
then lost 40%. You would think at first glance that this is a chart for
an inverse gas ETF that would only profit from falling gas prices.
However, such an instrument doesn’t exist.
This dreadful state of affairs was brought about by the intricacies of contango, where far month contracts in the futures markets are trading at premiums to the front month. As each month expired, the
managers of UNG bought fantastically rich forward contracts, and then
rode them all the way down to spot, as they were mandated to do by their
prospectus. They then repeated this exercise every month.
If the
contango continues indefinitely, the UNG will eventually approach zero.
Moral of the story: don’t just punch in a symbol and hit enter. Read the
damn prospectus first.
Since we are discussing CH4, I have to tell you that the outlook does not look great. We are just coming out of one of the worst winters in history, and NG only managed a rally from the $2.40/MCF low to six bucks
and change. Gas in storage is about to rise again, and gas producers,
like Chesapeake Energy (CHK), XTO Energy (XTO), and Devon Energy (DVN),
are racing to out-produce each other in the hope of offsetting falling
prices with increased volumes. The price collapse is prompting a
Darwinian consolidation of the entire industry. The spot price for NG
has already backed off to $4.08. It’s sad to see such a great molecule
fall on such hard times. Pitiful, really.
This is all happening thanks to the new miracle fracting technology, which has suddenly and unexpectedly been used to discover a 100 year supply of natural gas. The Marcellus shale in Pennsylvania, Ohio, New
York, and West Virginia could power the entire East Coast for decades.
The Haynesville shale in Louisiana, Texas, and Arkansas could knock oil
out of the box for power generation in the South. Huge fields in North
Dakota are yet to be fully developed. All this makes the construction of
a gas pipeline from Alaska pointless, once a pet project of former
governor Sarah Palin.
It seems that now only need poke a straw in their backyard to obtain a lifetime supply of clean burning energy. Gas majors are now jockeying to exploit untapped shale fields in Europe, with Poland leading the
charge in deploying fracting technology. They must be sweating bullets
in Qatar, which just invested $50 billion in facilities intended to
export NG to the US and Europe. Looks like they’ll have to flare it
instead.
The problem is that ETF’s have become a great money spinner for Wall Street, replacing earlier income generators, like CDO’s, that died in the crash. By the beginning of this year, some 836 ETF’s had been
created worth $782 billion, generating massive management fees and
trading commissions for the industry. The big question is, when one of
these marquee ETF’s goes under, will it sour investors on the entire
asset class? UNG has already cratered from $65 in July, 2008 to $7.68
today, a plunge of 88%, costing investors billions. Imagine how a
leveraged ETF would have fared. Will this be the ETF that kills the
goose that laid the golden egg?
To see the data, charts and photos that back up this story, as well as other iconoclastic and out of consensus analysis, you can always visit me at www.madhedgefundtrader.com
, where the conventional wisdom is mercilessly flailed and tortured
daily, or listen to me on Hedge Fund Radio at http://www.madhedgefundtrader.biz/
.
Views: 76
Replies to This Discussion
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Permalink Reply by Checkmateking on -
We must find alternative uses for NG, it will be a shame for NG to hover around 3-4 dollars all summer while oil could approach 100 dollars a barrel
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Permalink Reply by Henry on
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All the advice was to steer clear of UNG, unless you really, really, really (!) knew what you were doing. UNG was never meant to be a long-term investment in natural gas. If you want to invest in a natural gas fund, try FSNGX -- Fidelity Select Natural Gas. At least it behaves the way a mutual fund ought to behave.
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Permalink Reply by Mac Davis on
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That may be good advice, but realize that FSNGX is not a natural gas fund, it's a natural gas COMPANY fund.
I toyed with the idea of trying to figure out how to go short UNG or USO on the basis that the fund is an inherent money loser, but that's sort of beyond my level of weirdness in investing that I'm willing to do.
In general, an ETF can be a great thing, but you have to be careful about what the underlying security is. There's a vast difference between, for instance, the S&P 500 ETF and the triple short S&P 500 ETF. Lots of the "inverse" ETF's lost money even when the underling commodity would indicate it should have gone up.
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Permalink Reply by Henry on
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Mac, You are right. It buys companies, and is not a direct play on the price of NG. I'm not bold enough to go for the complicated, more risky stuff.
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Permalink Reply by adubu on
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Skip-Peel---Your 100% correct about UNG. I learned the hard way brought 4000 shares when spot henry hub hit $1.80--UNG was 13 out at 9 when NTG rally to $5.50. NG up 300% and UNG down 31% (Loss $16,000)all due to contango as you explained above. I agree on your forcast also how sad it is!!!!!
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Permalink Reply by Skip Peel - Mineral Consultant on
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What is of significance to ETF investors (UNG being a good example) is also of significance to those who purchase minerals or royalty interests. 2010 will be a challenging year.
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Permalink Reply by essay on
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paying a broker that knows how to use futures options (or learn yourself) might be the best way to hedge vs. lower NG prices.
today's small gains on the futures look like a dead cat bounce to me, but what do i know. i think we're probably going lower, it's going to take a minor miracle to reverse this trend.
i would say that anything below 3 bucks or so on a sustained basis and chesapeake, with its substantial debts, will be a very juicy target for a major looking to increase reserves, and i do own a few modest shares of this stock bought at about half of where it is currently, and i wouldn't buy it right now, it might see sub-20 again easy if things get ugly. seen buyout evaluations at anywhere from 30-40 a share, though, but if it's a fire sale, could be lower.
seen a bunch of sharp folks endorse pipeline stocks and dividend-paying utilities but i can't recommend any.
i'd be careful investing overseas, especially in china. i'd check out india.
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Permalink Reply by Carter on
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definitely with volatility $VIX being so low right now. still have to time it perfect.
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Permalink Reply by Cheerleader on
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Skip and Jim Cramer are right on about UNG!!!!!!
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Permalink Reply by adubu on
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I would not insult Skip by putting him in the same boat with the tout master Jim Cramer!!!!!! :))
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Permalink Reply by Skip Peel - Mineral Consultant on
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Thanks, adubu. I would not share a boat with Mr. Cramer. One of us would have to take a swim! LOL!
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