Inside the Slump in the Gasoline ETF

Zacks

Trading in the energy commodity space, in particular oil and gasoline, has seen a rough start to the year on supply/demand imbalances that are pushing prices down. The signs of a slowdown in China, the world's second-largest oil consumer, and emerging market turmoil have added to the woes (read: 3 Energy ETFs with a Choppy Start to 2014).
 
This is particularly true with the United States Gasoline ETF (UGA) that lost about 6.76% so far this year, much more than the loss of 2.98% for the broad PowerShares DB Energy Fund (DBE), 5.55% for United States Brent Oil Fund (BNO) and 2.27% for United States Oil Fund (USO).
 
Supply is Increasing
 
U.S. production is growing at a faster clip thanks to shale formations, and newly tapped oil and gas fields in North Dakota and Texas. Further, several closed locations are resuming production across the globe and Canadian oil sands are seeing continues growth, leading to a supply glut (read: Play the U.S. Oil Boom with These Energy ETFs).
 
According to the latest report from the EIA, gasoline production increased nearly 9.2 million barrels per day for the week ending (January 24).
 
Additionally, Iran’s agreement with the major world powers to curb its nuclear activities in exchange for softer international sanctions has finally erased the decade-long tension and enabled Iran to export more crude, once again helping to send prices lower.
 
Demand is Falling
 
Demand for gasoline is falling on the back of a seasonal trend (severe cold and snowstorms), growing popularity of fuel-efficient vehicles, and changing consumer habits.
 
Growing supply for crude is the major reason for the slump in the gasoline prices. According to the U.S. Energy Information Administration (EIA), the average gasoline price is expected to fall from $3.51 per gallon in 2013 to $3.46 per gallon in 2014 and further to $3.39 per gallon in 2015.
 
UGA in Focus
 
The fund provides investors exposure to front-month gasoline futures, tracking RBOB gasoline for delivery to the New York harbor which is traded on the NYMEX.
 
The ETF is less liquid with daily trading volume of about 21,000 shares, suggesting a wider bid-ask spread. As such, investors may have to pay extra beyond the annual fee of 60 bps per year. The fund has managed assets of $53.5 million so far.
 
As traders need to roll from one future contract to another, the fund is susceptible to roll yield. 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 and the opposite holds true for contango (read: Don't Be Fooled by the Gasoline ETF's Rise).
 
Currently, the gasoline market is in contango, which is bearish for the commodity and the gasoline ETF UGA. However, this situation might continue at least for the near term and might rebound in May as the RBOB gasoline futures contract for May is trading higher than the next month contract (June), signaling positive roll yield.
 
Bottom Line
 
Given the current bearish fundamentals, we advise investors still long on gasoline to get out of this weak space or consider a short play on the product. In fact, the sentiment for the overall energy commodity market is negative, and there may be better picks out there, such as in the agricultural market, at this time.
 
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