Natural gas seems to have fallen out of favor in 2009. Over the past year the spot price of natural gas has fallen from a high of $14 to below $3. The primary reasons for the free-fall in price is the sizable natural gas inventories around the world combined with a relatively stubborn natural gas industry which refuses to slow production in the wake of a global recession and economic slowdown.

IN PICTURES: Eight Ways To Survive A Market Downturn

Widening Gap
As the bifurcation between oil and natural gas began to play out this year, many looked at the widening gap in the oil to natural gas price ratio as an opportunity to long natural gas, which they thought was merely lagging the recovery in oil prices by a few weeks. As weeks turned into months, the oil to natural gas ratio has reached historic levels (over 22-times as of Tuesday). Those that bet on natural gas' recovery through the United States Natural Gas Fund ETF (NYSE: UNG) have felt the brunt of the pain; UNG is a mess. Shares are down 50% in 2009 alone, and 17% in the last 3 weeks to trade at $12, down from a high of $63.89 last summer. The fund has also, for all intents and purposes, reached its position limits set forth by the CFTC, all but deeming UNG a closed-end fund due to its inability to issue new shares. The lack of new shares has led UNG to trade at an almost unheard of premium of 11% over its NAV.

In a desperate maneuver to create more units, UNG's managers entered into a $250 million over-the-counter swap contract in July, and recently announced that they had also entered into a $500 million natural gas total return swap. By entering into these swap contracts, UNG has added significant risk to shareholders by introducing a large amount of counterparty risk into the equation. It's a desperate move by a desperate group.

Long Road Ahead
Having performed equally as badly, the Barclays IPATH Natural Gas ETN (NYSE: GAZ) has also been a big loser of late. Down 50% YTD and 11% in the past 3 weeks, GAZ has managed to keep its premium below 9%. Also, since GAZ's holdings are quite a bit smaller than UNG, the former fund may have an easier time in reducing its premium. That being said, since both funds hold near-dated future contracts (currently September and October '09 contracts) they may be in for some hard times in the medium term as well. As the current contango in natural gas futures flattens, as evidenced by the large open interest on natural gas puts for October, natural gas prices may not recover until 2010. Even in that case, with the large reserves still remaining and the majority of natural gas producers refusing to stop production, capacity may be reached rather soon, putting greater downward pressure on natural gas prices.

Bottom Line
Right now, the outlook for natural gas and UNG along with GAZ does not look promising. I would suggest staying away from these funds for the foreseeable future and waiting to see if their managers can straighten out the mess that these funds have gotten into. (To learn more, see our Oil And Gas Industry Primer.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  2. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  3. Mutual Funds & ETFs

    Top 3 Commodities Mutual Funds

    Get information about some of the most popular and best-performing mutual funds that are focused on commodity-related investments.
  4. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  5. Investing News

    Top Tips for Diversifying with Mutual Funds

    Are mutual funds becoming obsolete? If they have something to offer, which funds should you consider for diversification?
  6. Professionals

    Top Stocks to Short, Go Long On to Beat the Market

    A long/short portfolio can help weather a variety of market scenarios. Here's how to put one together.
  7. Mutual Funds & ETFs

    Top 4 Asia-Pacific ETFs

    Learn about four of the best-performing exchange-traded funds, or ETFs, that offer investors exposure to the Asia-Pacific region.
  8. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  9. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  10. Savings

    Become Your Own Financial Advisor

    If you have some financial know-how, you don’t have to hire someone to advise you on investments. This tutorial will help you set goals – and get started.
  1. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  4. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  5. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  6. How do futures contracts roll over?

    Traders roll over futures contracts to switch from the front month contract that is close to expiration to another contract ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!