The United States Natural Gas Fund (UNG) has found itself at the top of a number of lists this year. The natural gas fund has been one of the most popular exchange-traded products, with cash inflows to date in 2009 of $5.4 billion, more then four times the assets UNG maintained only a year ago. From a performance perspective, it’s also been one of the most disappointing: despite a furious rally in recent weeks, UNG has been crushed by regulatory uncertainty, contango in futures markets, and perhaps even its own popularity in 2009, losing more than 50% of its value so far on the year (see the complete list of worst performing ETFs in 2009).
UNG has also been one of the most volatile ETFs of the year, regularly posting big gains or losses in a single day. In fact, UNG has gained or lost at least 1% 192 times so far in 2009, or in roughly 77% of all trading sessions. The fund has swung by at least 5% a whopping 37 times, or more than once in every seven sessions. Commodities are known to be somewhat volatile investments, but the fluctuations exhibited by UNG this year are impressive for any security.
These figures seem more likely to be associated with a leveraged ETF than with one purporting to track a commodity. UNG has actually been more volatile than many of the leveraged ETFs available today. By comparison, the ProShares Ultra S&P 500 (SSO), which seeks to deliver daily results equal to twice the daily returns to the S&P 500, swung by at least 1% in about 65% of trading sessions this year, and moved by 5% only 13% of the time.
|Daily Gain/Loss||% of ’09 Sessions|
|At Least 1%||77%|
|At Least 3%||38%|
|At Least 5%||15%|
Behind The Volatility
The reasons behind UNG’s wild ride in 2009 are numerous. For starters, the spot price of natural gas can be volatile. Demand for the commodity depends both on the level of activity in the manufacturing sector as well as heating needs. Because extreme weather is, by its very nature, unpredictable, changes in forecasts can lead to swings in demand: expectations for more moderate weather can send gas prices lower while predictions of a cold snap can send prices higher. Natural gas often sees big movements following a variety of statistical releases, including bulletins on inventory levels and manufacturing activity.
But while many investors in the fund are looking to gain exposure to natural gas prices (and UNG is still one of the best ways to do so), the spot price of natural gas is only one of the drivers behind UNG’s share price, and often one of the least important (this chart presents a very interesting situation indeed).
Ironically, an uncertain regulatory environment has contributed significantly to UNG’s volatility in 2009. As the fund has swelled in size, it has accounted for a bigger and bigger portion of the futures market on natural gas. This drew the attention of regulators of futures markets, and earlier this year caused UNG to temporarily cease issuing new shares. Following this development, UNG began to trade more like a closed-end fund, with market prices reflecting a meaningful premium to net asset value as demand continued to grow for a limited supply of shares. UNG’s premium to net asset value (i.e., UNG’s market capitalization as a percentage of the underlying assets) has ranged from 0% to nearly 20% this year.
Finally, UNG’s “roll yield,” the costs incurred when selling near-month contracts and using the proceeds to buy second-month contracts, have had an impact on the fund’s returns this year as well. Given UNG’s massive size, the degree to which the fund moves the market when rolling holdings can be difficult to predict, and can have a material impact on the value of the underlying holdings (see What’s Wrong With UNG? for a more in-depth look at this issue, and sign up for our free ETF newsletter for updates on UNG and other funds).
Volatility = Popularity?
When combined, these factors result in an exchange-traded product that is among the most volatile available to U.S. investors. UNG’s volatility may be one of the reasons for its tremendous popularity — the wild swings in share prices present plenty of opportunities for active traders to generate big losses in a relatively short period of time.
UNG can be a very powerful tool if used correctly, but investors should be aware of the underlying volatility of the product. The fact that UNG has proven to be more volatile than many leveraged ETFs highlights the risk profile that comes along with an investment in natural gas.
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Disclosure: No positions at time of writing.