ETFs are designed to track the changes in the price of benchmark natural gas futures contract in percentage terms not in dollar terms meaning if the spot price rises 5% you expect the ETF to rise 5% as well. However, by investing in month to month futures contracts, these ETFs suffer from the inherent risk of Contango which have been prevalent in natural gas futures market. The following hypothetical example explains the contango situation:
Let’s assume the spot price for natural gas (immediate delivery) is $1.00 for 2,000 mmBtu and the value of a position in the near month futures contract (the contract with the closest settlement date where you take delivery) is also $1.00 for 2,000 mmBtu. If you are an investor holding a near month contract in order to track the spot prices of natural gas and you wish to avoid taking delivery of the commodity, you need to sell your current near month contract before it reaches settlement date (expires) and invest in the next month contract.
Contango is when you buy the next month contract for a higher price than the current near month contract. In our scenario, the price for buying the next month contract is higher at $1.02 for 2,000 mmBtu or 2% more expensive than the current front month contract. The value of the next month contract you bought falls as it approaches expiration and becomes the new near month contract with a price of $1.00. You just lost 2% + commission costs to roll your position from one month to another. This is exactly what happens when future natural gas prices are higher than spot prices.
Contango & Backwardation vs Spot prices – Click to enlarge
UNG, the most popular natural gas ETF, has been suffering from a persistent level of contango due to falling natural gas prices. Holding a long position in UNG burned many long term investors as the fund lost more than 95% of its value since inception and has been forced to undergo several reverse splits. The good news is there are 2 ways to profit from a contango market:
- First, since UNG is very liquid, you can short the ETF as shares are easy to borrow from this large fund. However, shorting UNG exposes you to the extreme volatility of natural gas prices due to the fund holding front months futures contracts.
- The second and better way is through an innovative long-short strategy designed to capitalize on a potential contango market environment minus the volatility of natural gas prices. This is where GASZ ETN comes in.
UBS E-TRACS Natural Gas Futures Contango ETN (NYSE: )
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MER: 0.85%
GASZ allows you to bet on a persistent contango environment in the natural gas futures market. The ETN is linked to the performance of the ISE Natural Gas Futures Spread™ Index (GYY) which shorts the near month natural gas futures contracts and goes long the midterm Henry Hub natural gas futures contracts.
For as long as contango exists, GASZ will be able to profit from its short positions in near term contracts. The biggest risk is for NG prices to fall in backwardation (opposite of contango). But from looking towards 2020, GASZ seems to be the perfect vehicle to hold as NG is virtually .
Live ONE YEAR Chart of the The Natural Gas Futures Contango ETN– Symbol GASZ
GASZ is doing a great job capitalising on contango
GASZ should be viewed as a new tool investors can use solo or in conjunction with other funds in their investment/trading strategy. But keep in mind that this fund is in no way designed for a buy and hold move and may not be suitable to express a long term bullish view on spot prices. If spot prices rally on the back of speculative price action, GASZ will take a hit as contango in the futures curve eases. The fund’s liquidity is light so monitor your positions carefully and keep stop losses at hand as a temporary backwarded market is always a possibility. If you have a bullish take on natural gas prices for the long run, a natural gas stocks etf might be a better option to consider.
Disclaimer: the information presented above is only for informative purposes. It is in no way an encouragement to buy or sell the aforementioned securities.