HardAssetsInvestor

Written by Sumit Roy  |

June 17, 2011

Contango Killers? New ETNs Play Energy Calendar Spreads

Details

Two new products aim to make betting on contango easier than ever.

In an odd case of product following controversy, two new ETNs designed to make playing the same calendar spread used by Arcadia traders in their alleged market manipulation are now available in a convenient exchange-traded note.

Natural gas has been out of the headlines for a while now. The fuel attracted intense attention during late 2009 and through 2010, as investors scrambled to catch the bottom in the plunging commodity. That bottom came in September 2009, yet the vehicle that many investors chose to invest in natural gas with—the United States Natural Gas Fund (NYSE Arca: UNG)—kept on sinking.

Indeed, UNG has fallen consistently since then, most recently hitting a new all-time low in March of this year. The reason for much of UNG’s poor performance isn’t entirely unrelated to the actual decline in natural gas prices, but contango is what really explains UNG’s massive underperformance against spot natural gas.

This phenomenon should be well understood by investors by now. But the knowledge has come with a steep price tag for the many who likely had to learn from experience. Since the beginning of 2009, spot natural gas prices have fallen 18 percent, while UNG has plummeted 78 percent.

Year-to-date in 2011, the differential is still quite stark, with spot prices down 2 percent and UNG down 12 percent; the fact remains that persistent contango in the natural gas market continues to take a bite out of returns in funds such as UNG.

We observed a similar phenomenon in crude oil, as the United States Oil Fund (NYSE Arca: USO) has strongly underperformed the spot West Texas Intermediate prices that it attempts to track, though not nearly to the extent observed in the UNG-natural gas situation.

Given these ugly return figures, it’s unsurprising that many ETF providers have attempted to create new products to ameliorate the impact of contango. The United States 12 Month Natural Gas Fund (NYSE Arca: UNL), for example, holds a basket of natural gas contracts along the futures curve, not just the front month.

This strategy has helped to some extent; year-to-date UNL is down 9 percent, less than UNG’s 12 percent. In UNL’s case, while contango is minimized, it isn’t eliminated.