An ETF designed to track natural gas futures has rallied 60% from its April 2012 low. That seems like a great performance but it’s less than half of what the commodity’s spot price has returned the past year.
Since the April 2012 lows of around $1.85 per million British thermal units, natural gas prices have surged 122%. In comparison, the U.S. Natural Gas Fund (UNG) has increased 59.6% from its April 2012 low.
Over 2012, the ETF dropped 27% while the spot gas price increased 15%, writes Brendan Conway for Barron’s.
Natural gas ETFs are designed to track natural gas futures rather than the actual spot price and typically roll futures contracts before they mature. Consequently, their performance suffers when natural gas futures are in a state of “contango” – when longer-dated contracts are more expensive than the front-month contract. [Commodity ETFs and Contango]
When looking at a normal futures curve, investors will note that futures with longer maturity dates often have higher prices – this is partly due to fundamentals like storage costs or financing costs tacked on to a future expected spot price.
The bottom line for investors is that futures-based commodity ETFs such as UNG won’t replicate the spot price over longer periods.
“Funds trading futures contracts will realize such disparities because of the mechanics of the futures market. UNG invests in near-month futures contracts, and as each month draws to a close it has to ‘roll’ its position forward. Effectively, the fund sells its soon-to-expire position and purchases a contract further from expiry to avoid physical delivery,” writes Morningstar analyst John Gabriel in a profile of UNG.
“When the prices of those back-month contracts exceed the price of the front-month contract (known as a state of contango), the fund loses money each time it rolls its position. In contangoed markets, a fund like UNG can suffer heavy losses even as natural gas prices rise, warranting investor caution,” he adds. [Natural Gas ETFs to Play the Rally]
Unfortunately, it’s impossible to construct ETFs based on a commodity’s spot price. Instead, investors can choose ETFs that track futures contracts, or shares of commodity producers.
U.S. Natural Gas Fund
For more information on natural gas, visit our natural gas category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.