Why I’m shorting the natural gas ETF – B. Ruchert-Dixon (UNG, USO)

Author: Brendan Ruchert-Dixon
Covestor model: Alpha Trapper
Disclosure: Short USO, UNG

This month of March was a bit disappointing for the model, flat to slightly negative just like the stock market. On a positive note, the model saw a lot less volatility than the S&P 500, making it a less scary place to be during the mid-month drop.
The trades in March – including a new short position in United States Oil Fund LP (NYSE:USO) – continued themes I discussed in previous reports.

One ETF I’ve been shorting for some time, but haven’t discussed much yet is the United States Natural Gas Fund, LP (NYSE:UNG). It tracks the prices of near-month natural gas futures. The reason I’m negative on this fund has much more to do with contango than with the natural gas price itself. Every month UNG is forced to sell its futures that are about to expire in order to buy the futures for the following month. After accounting for expected seasonal price changes, this later future is almost always more expensive than the expiring future, which must then converge to the current price of natural gas.

To get a sense of the prices at varying expirations, go to this site (http://data.tradingcharts.com/futures/quotes/NG_.html) and look at the difference between any month this year and that same month a year later (that is, for 2012). Part of the price difference may be due to speculation that prices will move higher in the future (this is what can make other futures-based ETFs like VXX also attractive to short). But for natural gas (and oil to a lesser extent), there is also an added premium related to storage. Natural gas is rather expensive to store, and prices at future dates tend to reflect not just the expected price of the gas, but also the cost of storing it until that date.

Could prices still go up enough to overcome these costs and make UNG a winner? Sure they could, temporarily. But over the long term I’d say the odds are against it.

Here’s how UNG has performed over the past year, via Google Finance: