HardAssetsInvestor

Written by Olivier Ludwig  |

May 17, 2012

Buyer Beware: NatGas Funds UNG & GASZ Take Different Paths To Performance

Details

While both funds are driven by natgas prices, they possess two very different approaches to contango.

UBS sent out a press release recently extolling the virtues of its ETN that’s designed to profit from contango in natural gas markets. I had to investigate.

Specifically, UBS was comparing returns of its ETRACS Natural Gas Futures Contango ETN (NYSEArca: GASZ) with those of the United States Natural Gas Fund (NYSEArca: UNG).

While the comparison of GASZ and UNG may not be apt, or even fair, let’s just say things didn’t look too good for UNG in that press release, and that in the past month, as gas prices have rallied, things don’t look nearly as good for GASZ.

Since last June when GASZ came to market through the end of April of this year, UBS—citing Bloomberg data—said GASZ was up more than 23 percent, while UNG fell more than 60 percent. In the six months ended April 30, GASZ gained almost 20 percent, while UNG fell 54 percent.

While the numbers aren’t lying—and you have to be somewhat impressed that GASZ made money when gas futures were plunging amid booming production and somewhat stagnant demand—there’s more to the story, as I suggested above.

First off, these two exchange-traded products, while both focused on natural gas futures, are like comparing apples and oranges.

GASZ is really an investment strategy, with half of every dollar invested devoted to going short the front-month contract and the other half weighted equally among the 12^th-, 13^th- and 14^th-month contracts on the futures curve, which UBS collectively refers to as “midterm futures.”

Half The Story

GASZ proved to be a winning way to play the gas market in the past year, both because prices were falling and because front-month prices were falling faster than midterm futures. That means that contango was increasing, which is exactly what GASZ is designed to benefit from.

UNG is meanwhile as close as a “pure beta” investing approach to futures as is possible, if such a term even applies to rules-based futures investing.

It only owns front-month contracts, which means it lives and dies with the vagaries of contango—wherein the front-month contract is cheaper than those further out on the curve.

That means each time UNG’s managers roll into the next contract two weeks before the front-month contract expires, they’re paying a bit more for the new contract than what they fetch for the one that’s about to expire.

In the real world, that means that while spot gas futures fell about 75 percent from their peak in 2008 before the market meltdown to mid-April of this year, UNG lost about 95 percent of its value and has undergone two reverse share splits in as many years to help pump up its wilted share price.