Natural gas prices have staged an impressive bounce the past few days after hitting a decade low earlier this year.
The commodity is down about 80% from its peak in 2008 with new advances in extraction leading to a supply glut. However, exchange traded products are seeing trading volume trend higher during the recent rebound.
Investors need to remember that natural gas ETFs won’t track the commodity’s spot price perfectly because they use futures contracts or invest in shares of producers.
“After slumping for longer than anyone cares to remember, it seems like natural gas is fighting its way to higher prices, however volatile that path may be,” writes Jared Cummans at CommodityHQ.
Investors betting on a recovery in natural gas prices with exchange traded funds and notes need to keep several factors in mind. First, ETFs designed to track futures contracts can suffer from “contango” in the futures market.
UNG, the $988 million natural gas ETF has” suffered from the plunge in gas prices for years,” writes Dan Caplinger for the Motley Fool. “It uses futures contracts to give investors direct exposure to the price of natural gas. But the ETF has another problem: Because of its focus on near-term futures contracts, a peculiarity in the gas futures markets has caused it to produce losses well in excess of the drop in the commodity price. This condition, known as contango, still exists, and as long as it does, the ETF will underperform.”
As of June 18, UNG was up 19.3% for the trailing week but still down 29.2% for the year-to-date period, according to Morningstar.
“To address the problem, other futures-following gas ETFs use slightly different strategies. Both U.S. 12 Month Natural Gas (UNL - News) and Teucrium Natural Gas (NAGS - News) go beyond near-term contracts to try to overcome contango, and their losses over the past year are indeed less severe,” Caplinger said.
However, GAZ is trading at a premium to indicative value of more than 50%, setting investors up for potential losses unrelated to the movement of natural gas prices.
Barclays, the issuer for GAZ, suspended new share issuance in 2009. [Natural Gas ETN Premium Tops 100%]
Finally, there are ETFs that avoid the futures market altogether by investing in natural gas producer stocks. Funds in this category include First Trust ISE-Revere Natural Gas Index Fund (FCG - News).
From a technical perspective, some analysts see a bullish inverted “head and shoulders” pattern in natural gas prices.