U.S. Nat. Gas (UNG): The ETF Unwind Begins

In my blog posting on July 3, 2009 titled "ETF: Mediocrity with No Pretense of Value," I said:

"The structure of a scheme like this [ETFs] only works when the market continues higher or new money floods in."

Are we on the cusp of seeing this situation with EFTs unravel? Currently, the U.S. Natural Gas Fund (UNG) is being forced into the position of issuing new shares to offset the expiration of old creation units. Without the issuance of new units, UNG has become priced well above net asset value as new money has flooded in with a diminishing number of units.

Some have said that the real problem is the fact that UNG has been too successful at raising money. I believe that the flood of money into the fund shouldn't be considered a success, instead it should be considered bordering on a ponzi or pyramid scheme. Again, no value exists unless more money comes into the fund. If the spigot of new money was turned off, in a matter of months the fund would end up worthless, unless the price of natural gas goes up.

One guy, Jim Cramer, said back in June that he believed that the flood of money into the ETF would actually allow UNG to push up or prop the price of natural gas. However, when you view the history of natural gas prices over the last year (courtesy James L. Williams WTRG Economics at WTRG.com) you can easily see that, in this case, UNG and the futures price of natural gas are in complete agreement.

Most market professionals would claim that a changing of the rules is the real reason why there is turmoil in the commodity ETF market which is reminescent of the FIRREA rule change on Savings and Loan institutions before the S&L crisis. The reality is that the rule changes are an outgrowth of lawsuits from overzealous attorneys on behalf of misinformed investors. In their zeal to create hedging and leveraging opportunities to the retail investors, leveraged ETF distributors didn't emphasis enough the fact that the risk of loss was far beyond known market risk. Unfortunately, like the FIRREA rule change we could see painful unintended consequences.

Oh, by the way, did I mention that there is no real intrinct value to ETF funds. Whether they are Index ETFs or leveraged ETFs it is really all about the luck of the draw. If a lot of money is coming in at the time that you own the fund then the net asset value (NAV) will move in-line with the market. However, when net redemptions exceed new money coming in, the value of the ETF declines. The only hope is that market for that fund is in a rising trend.

The news on UNG's plight isn't all that encouraging even though the issuance of more shares is meant to mitigate the disparity in the NAV. My hope is that things don't get to out of hand as we enter the most volatile months in the year. -Touc

The following are the latest articles on what may become the great ETF unwind.

Please revisit Dividend Inc. for editing and revisions to this post.

Comments are closed.