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UNG: The Un-Natural


Be careful with the latest rally in natural gas.


"Pick me out a winner Bobby." --Roy Hobbs

If only it were that easy. Mixing futures contracts and ETFs is like the The Natural's flame-throwing Nebraska farm boy adding a circle change as a second pitch.

Plenty of stories were written about rolling natural gas contracts costing United States Natural Gas (UNG) holders money on the way down for natural gas. Then more players started swinging against their long-only rolling bets, and you get this instead, as reported by Bloomberg:

Speculators trying to profit from the US Natural Gas Fund's roll of futures contracts got "slaughtered" and helped boost volatility as gas prices surged. Gas for October delivery rose 27% on the New York Mercantile Exchange as traders had to cover their bets that the gas fund's sale of the front month contract would reduce the price. Volatility jumped to the highest level since Amaranth Advisors LLC collapsed in September 2006. Speculators shorted October gas, anticipating that the $4 billion gas fund would push prices down when it began selling its October contracts on Sept. 14.

Regardless of the reasons, United States Natural Gas has attempted to break its slump and move above its 100-day moving average many times, as you can see below. And notice the volume of swings investors took trying to find the bottom.

Click to enlarge

The last time it closed above it was July 16, 2008. That's what they call a trend in this business.

That trend is even more conspicuous inside of an overall CRB Commodity Index, which is up this year. I've written about this often, but as commodity index funds have shrunk by two-thirds in size (yes, it's true Congressmen, speculators lose money too, but without asking for windfall rebates), I believed the most significant outcome would be a market of commodities trading more independently than a commodity market trading dependent on flows.

Since the beginning of this year, United States Natural Gas has cost its "shareholders" 50% of their capital. By comparison, if you had been just as wrong and bought the most expensive futures contract on the board, the December '09 Natural Gas Contract, it opened the year at $7.12 and is now $5.50.

I point this out for two reasons. Futures are not riskier than stocks and ETFs. Just like stocks are not riskier than bonds, nor are bonds riskier than cash. Risk is determined by price and price alone. But the hidden risk isn't fully understanding what you own. Be careful out there. With good old fashioned homework and an ample supply of sell disciplines and stops (and patient buy stops) your nimbleness as an individual adviser or investor has never been more valuable in my opinion.

And be careful with the "rally" in natural gas. I have no position, but it's been my least favorite commodity over the past year because of a perfect storm of new and historic supplies coming online as domestic consumption slowed.

The story to believe in now for the bulls is production is being taken down. Listen to the big boys and they'll tell you that. Better yet, watch what they do instead.

Maybe I'm wrong, but I just wish it didn't feel like asking my kids who's eating their broccoli tonight. "Oh, we all will Dad." But then none do. It always takes more incentive by way of a few cookies. I guess it takes more kicking and screaming for the big boys as well.

My firm continues to favor growing domestic consumption in developing countries for raw materials in tight or shrinking supply.

"You know my mama wanted me to be a farmer." --Pop Fisher, from The Natural

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No positions in stocks mentioned.
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