The Investment That Wouldn't Die

For more tales of financial frights, our Halloween special series, Avoid These 8 Investing Horror Shows, won't disappoint!

From overleveraged Delta Petroleum (Nasdaq: DPTR  ) to overhyped Houston American Energy (Nasdaq: HUSA  ) to over-the-hill Energy Conversion Devices (Nasdaq: ENER  ) , there's no shortage of spooky investments in the energy sector. These are all relatively small companies, though, and unlikely to draw in space-monster-sized amounts of money. For me, the most terrifying investment vehicle in the space is an ETF that has vaporized untold amounts of wealth since some mad scientists of Wall Street brought it to life in 2007. I'm talking about the United States Natural Gas Fund (NYSE: UNG  ) exchange-traded fund.

The ETF's popularity is easy enough to understand. Like the SPDR Gold Trust (NYSE: GLD  ) or the Powershares DB Agriculture Fund (NYSE: DBA  ) , UNG provides investors a way to bet on the direction of a commodity (or basket of commodities, in the case of the agriculture fund) without having to accept company risk, dabble in futures contracts, or take delivery of a silo full of grain.

With commodities increasingly viewed by investors as an asset class, such funds are all the rage with pension funds, hedge funds, and retail investors alike. UNG trades more than 20 million shares daily, or well over $100 million by dollar volume. The liquidity here is tremendous, keeping the fund price closely in line with daily net asset value. Nothing frightening so far, right?

The problem with UNG, as well as countless other ETFs that invest in near-month futures contracts, is that the fund's value gets chewed up like a zombie victim as the contracts get rolled from month to month. Compounding this issue of "roll yield" is that the larger the fund gets, the harder it gets to nimbly exit expiring contracts and enter new ones. The fund spreads its roll dates over four days, which in theory should help to minimize the impact of its trading, but I still suspect that other savvy market players are able to game this pattern.

After the past few years' performance -- shares are off roughly 85% since inception -- you'd think that investors would have run away screaming by now. For some reason, though, they just keep getting lured back in. Perhaps there's a mind-control device at work here. That, or investors think they can actually time a recovery in natural gas with great enough precision to avoid getting their faces ripped off by the Negative Roll Yield Mutant.

If you want to trade in and out of this ETF in a matter of minutes or hours, that's your prerogative. For those investors out there who, like me, anticipate an eventual recovery in natural gas prices but want to be able to ride out another year of depressed prices if need be, I'd suggest ditching this frightening fund in favor of a low-cost producer who can survive the current rig invasion. Two companies that potentially fit the bill are Range Resources and Southwestern Energy (NYSE: SWN  ) . You can read my case for the latter company -- one of the premier shale gas operators -- right here.

Looking for additional scary stories? We've got what you need in our Halloween special series, Avoid These 8 Investing Horror Shows.

Fool contributor Toby Shute doesn't have a Halloween costume planned, or a position in any company mentioned. Check out his CAPS profile or follow his articles using Twitter or RSS. The Motley Fool has a disclosure policy.


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  • Report this Comment On October 29, 2010, at 1:12 PM, DrBojangles wrote:

    You're dead right about UNG; it really is a store of dumb money for the arbitrageurs and front-runners to ceaselessly exploit, not to mention the built-in contango. Another egregious offender is the U.S. Oil Fund (USO) which has lost half its value since the fund's inception in April 2006.

  • Report this Comment On October 29, 2010, at 4:22 PM, rightlyso1 wrote:

    I believe that if the price of natural gas really spikes and continues to spike month after month, this ETF can reverse the negative effect of contango. But that will not happen with the steady development of shale gas.

    Still, strange and unexpected things have happened in all markets throughout history and ruling out that shale may not be forever can also be a big mistake. It will only take a) some government adverse ruling b) a revision to some numbers (too much 1st year depletion, etc. or anything as such to come to a new understanding of real supply/demand. In which case, we may see fireworks.

  • Report this Comment On November 01, 2010, at 10:28 AM, ambiguity wrote:

    Perhaps the problem with these ETF's is as follows (This is a question in the form of an answer!):

    A stock at net asset value is considered to be at rock bottom price and often a great value stock. But this ETF apparently sticks to this low price and does NOT rise above it! Thus this criterion for a great value stock is inverted in this case.

    That's all!

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