Caution: Natural Gas ETF Trading at Premium

Natural Gas ETFs have long been a top vehicle for traders as these products are extremely volatile and can predictably move in big swings whenever there is a report about storage or production. Thanks to this, many natural gas ETFs have become quite popular over the past few years accumulating a big chunk of assets.

While UNG is easily the most popular, investors have also started to embrace its counterpart, the United States 12 Month Natural Gas Fund ( UNL - ETF report ) showing this fund more interest as well. This fund is arguably better positioned for the long-term thanks to its more spread out methodology which doesn’t get as ripped apart by contango as its front-month focused ( UNG - ETF report ) counterpart (read Natural Gas ETFs Hot as Weather Cools).

Still, if investors are considering this product right now, they should be aware of a new development in the fund and the ability of its authorized participants to manage it correctly. Thanks to a regulatory requirement, United States Commodity Funds was forced to halt creations in the product until it receives SEC approval.

What Does This Mean?

Basically, Authorized Participants buy and sell baskets of a particular ETP, helping to keep prices in line with NAVs. When this is taken away, products often trade at a premium or a discount, and in the case of UNL, this has made it trade like a closed end fund with a slight premium, roughly 2% at last look (read 4 Best ETF Strategies for 2013).

Fortunately, according to IndexUniverse, the issue isn’t expected to last for more than a couple of days, but it does bring back some memories of the ( GAZ - ETF report ) debacle.

That ETN from iPath has been trading at a significant premium to its underlying value for quite some time thanks to a suspension of new share creations in this product as well. However, this has been an ongoing issue that has made the product pretty difficult for the average investor to get a grasp on, as sometimes the premium issue can drive the price more than the underlying fundamentals of the natural gas market.

Currently, GAZ is trading at a 14% premium over its NAV, so it is obviously experiencing a much more potent form of what UNL is currently seeing (see The Truth about Low Volume ETFs).

So for investors who were considering jumping into natural gas at this time, be wary of the situation developing in UNL. The premium isn’t expected to last too long so we could see a quick drop once creations are allowed once more (see 4 Best New ETFs of 2012).

In the interim, investors have a couple of natural gas ETF options out there that aren’t having similar issues. These include the following ETFs:

• United States Natural Gas ( UNG - ETF report ) - This is the most popular of the group and easily the most widely held. However, long term performance has been quite weak thanks to contango issues.
• Teucrium Natural Gas ETF ( NAGS - ETF report ) - This is probably the closest thing that investors have to UNL at this time. The product seeks to spread out exposure across the curve, but it has a relatively high expense ratio and much wider bid ask spreads (it is actually trading at a modest discount right now to NAV).

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