Ride High on Natural Gas Malaise

 | Apr 11, 2012 | 11:00 AM EDT
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Get a group of investors together and ask them about their largest frustrations, and you'll get hours of discussion over calls in both directions that should have delivered huge returns but fell flat for one reason or another. There's no shortage of disappointment and frustration in the current environment -- anyone who has checked their account statement recently has seen a boatload of red next to some large negative numbers. But few investments have been as maddening to watch crumble in recent years as natural gas. This, the so-called "fuel of the future," has emerged as a viable alternative to crude oil, yet has consistently declined in value.

Natural gas has frustrated those who have identified this commodity as an investable asset, because the investment thesis behind the fuel has generally been spot-on. Natural gas is becoming an increasingly popular power source around the world, and new technological advancements have increased distribution capabilities and dramatically expanded the universe of potential users. The market share of natural gas is virtually guaranteed to grow quickly in coming years.

Yet prices have plummeted, and investment vehicles that offer exposure to natural gas continue to post huge losses. There are, of course, some logical explanations for the abysmal performance of natural gas investments. Supply is increasing at an astonishing pace thanks to new discoveries, more than offsetting the surge in demand. Further, steep, consistent contango in natural gas futures markets has created strong headwinds for products offering exposure to this fuel.

Instead of getting mad, it's time to get even -- at least as far as your portfolio is concerned.

A handful of exchange-traded products are thriving off of that frustration, posting some mind-boggling returns as natural gas prices remain depressed and the slope of the futures curve remains steep in the short term. Short exposure to natural gas has been a winning combination for the last year, delivering mammoth returns as prices remain low and contango in futures markets continues to erode returns.

With global stock markets now stumbling, there's no reason to believe that the ride is over. Natural gas futures remain in steep contango, meaning the stage is still set for inverse products to prosper by effectively selling high and buying low. Here are a couple of exchange-traded products that tap into this concept, and have posted some solid results lately.

ProShares UltraShort DJ-UBS Natural Gas (KOLD): This cleverly tickered ETF offers daily negative 2x exposure to an index comprising natural gas futures. As prices have plummeted and contango has exacerbated losses to products such as United Natural Gas (UNG), KOLD has skyrocketed. This ETF has already more than doubled in 2012, making it one of the best performers in the ETF universe.

Natural Gas Futures Contango ETN (GASZ): For investors lacking the risk tolerance for a daily leveraged ETF, this ETN from UBS offers a unique opportunity to profit from structural inefficiencies in the natural gas futures market. GASZ includes a 100% long position in mid-term natural gas futures, along with a 50% short position in short term futures. That allows for net long exposure to the fuel, but positions investors to profit from contango at the short end of the curve.

The net result is truly impressive: GASZ is up about 18% on the year while UNG -- which holds short-dated natural gas futures -- has lost almost 40% over the same period. Both products have net long exposure to natural gas futures. However, by positioning its allocation strategically, GASZ has managed to profit from the same factors that have caused huge losses in UNG.

Chasing returns isn't always the best strategy. But the factors that have caused the strong performances to start the year -- weak economic fundamentals and steep contango -- remain at present. That sets the stage for a continued rally in both of these products in coming weeks.


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