By Dan Caplinger | September 13, 2012
The Motley Fool has helped ordinary people become better investors for nearly two decades. This month, we're reaching out to millions of investors to help guide them in their quest toward financial knowledge and independence.
Along those lines, I'm planning to take a look at many of the most popular exchange-traded funds in the market today. ETFs have skyrocketed in popularity, but it's important to understand exactly what you're getting when you buy an ETF. Today, I'd like to focus on the United States Natural Gas ETF (NYSE - UNG), a commodity ETF that seeks to track natural gas prices.
Natural gas has been one of the most volatile sectors of the market over the past several years. On one hand, soaring oil prices have made gas a more reasonably priced energy alternative. But huge discoveries of gas, especially using unconventional drilling methods like hydraulic fracturing, have boosted supplies of natural gas in the U.S. to the point at which huge gluts exist.
But just about everyone expects an eventual rebound in natural gas prices. Utilities Southern Company (NYSE - SO) and Duke Energy (NYSE - DUK) have taken steps to use more gas in place of coal, given both cost and environmental factors. Moreover, plans from Cheniere Energy (NYSE - LNG) and Encana (NYSE - ECA) to export natural gas overseas in liquefied form could remove supply from the North American market, capturing arbitrage opportunities as gas prices in other parts of the world are much higher.
The United States Natural Gas ETF has attracted a lot of that gas interest, with investors piling more than $1 billion into its units. It offers exposure to natural gas prices by owning futures contracts that move up and down with the price of the commodity.
But, the ETF has a problem that has plagued long-term investors. Futures contracts expire, and the ETF doesn't want to take actual delivery of the natural gas that its futures contracts entitle it to receive. As a result, the ETF has to replace or "roll over" its contracts with similar contracts from the following month. In general, though, the natural gas futures market tends to be in contango, a technical term meaning that the ETF has to pay a higher price on the replacement contracts than the prevailing price on the expiring contracts. Over long periods of time, this has produced a terrible total return for the ETF, trailing even the substantial declines that spot natural gas prices have posted in recent years.
In addition, United States Natural Gas ETF has somewhat higher costs than you'll see in many stock ETFs. With current annual expenses of $60 for every $10,000 you invest, and given the long-term effects of contango, the fund is more appropriate for short-term holding periods than for buy-and-hold investing.
Finally, investors need to be aware that because of its structure as a limited partnership, the United States Natural Gas ETF can also cause some complications at tax time. Specifically, rather than getting a simple tax statement at the end of the year that details the income you receive, you'll get a more complex form on Schedule K-1 that may require you to complete forms you've never had to deal with before. Indeed, even in years during which you don't get any cash dividends from your units, you may still have to report taxable income on the ETF's activities.
The United States Natural Gas ETF succeeds in giving short-term traders exposure to movements in natural gas futures prices, but as a long-term investment, it leaves much to be desired. To learn more about United States Natural Gas, use this link to the ETF's main information page.
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