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Commodities have captured the attention of investors in recent years, with big bull markets in many very important markets like agricultural products and precious metals. But ever since the financial crisis, one of the biggest losers among commodities has been natural gas.
Yesterday, though, natural gas prices soared 14% after the Energy Department released its latest data on gas stockpiles. Although the figures showed a rise of 67 billion cubic feet, that rise was smaller than most had expected, sparking interest among natural gas traders and raising hope that the bear market in natural gas prices may be ending.
Later in this article, I'll look at some natural-gas-related ETFs to see if they'd make good plays on a turnaround in natural gas. But to do so, let's first look at how natural gas prices got so low in the first place.
Why the long plunge?
Understanding the long drop in natural gas prices isn't difficult. Natural gas production has soared on the back of technological advances in drilling, with hydraulic fracturing playing a key role among unconventional energy methods in getting more gas out of the ground more cheaply than was possible just a few years ago. Even as big players Chesapeake Energy (NYSE: CHK ) and Devon Energy (NYSE: DVN ) take steps like cutting capital expenditures on gas projects, high supplies could persist for quite a while.
Meanwhile, demand hasn't risen to nearly the same extent. Although utilities are switching from coal to gas for electrical generation, the infrastructure for converting high-demand uses like transportation from oil to gas hasn't been developed yet. Moreover, although Cheniere Energy (NYSE: LNG ) and its peers are trying to build export markets for natural gas through liquefied-gas terminals, those will take years to start having an impact on the world market. The supply and-demand picture is still out of balance, and until it starts moving in the right direction, gas prices will still see at least some downward pressure.
ETFs for gas bulls
That said, value investors know that the time to get into an investment is when things look darkest. Several ETFs promise results based on the bull case for natural gas, but will they deliver? Let's take a look at some of them.
United States Natural Gas (NYSE: UNG ) has suffered from the plunge in gas prices for years. It uses futures contracts to give investors direct exposure to the price of natural gas. But the ETF has another problem: Because of its focus on near-term futures contracts, a peculiarity in the gas futures markets has caused it to produce losses well in excess of the drop in the commodity price. This condition, known as contango, still exists, and as long as it does, the ETF will underperform.
To address the problem, other futures-following gas ETFs use slightly different strategies. Both United States 12 Month Natural Gas and Teucrium Natural Gas go beyond near-term contracts to try to overcome contango, and their losses over the past year are indeed less severe. In the long run, though, they too may be vulnerable to tracking problems, especially if they gather enough assets to become a target of savvy futures traders who can take advantage of such situations.
Another product that has gotten a lot of attention is the iPath DJ-UBS Natural Gas Subindex Total Return ETN. It too purports to track gas prices. But lately, the shares have traded at a ridiculous premium to their actual value -- the current premium is about 40%, and reports have put it as high as 100% on previous occasions. As a result, even the ETN provider itself has said that the ETNs "will not track the price of the underlying natural gas futures index in a consistent manner and therefore are currently not suitable for most investors [emphasis in original]." When an ETN's own management company tells you to stay away, you'd be smart to listen.
Staying away from futures
With the troubles associated with futures-tracking investments, the other way investors can play a potential natural-gas turnaround is to buy shares of gas producers. The First Trust ISE-Revere Natural Gas Index (NYSE: FCG ) owns 30 different natural gas stocks, ranging from big names like Chesapeake and Devon to smaller producers.
As you'd expect, natural gas stocks have fallen along with the price of gas. But the First Trust ETF hasn't lost as much ground as the commodity, with a 27% drop for the ETF versus a more-than-60% drop in the United States Natural Gas ETF. Moreover, if gas prices start rising again, you can expect to see long-suffering gas-producer stocks rebound as well.
The better bet
Short-term traders looking to play a bounce in natural gas can use futures-tracking ETFs to try to score quick gains without running into most of the problems they have. Over the long haul, though, ETFs that own shares of energy companies will give you better exposure to the long-term prospects for the natural-gas industry.
Individual stocks can give you even better prospects from an energy boom than ETFs. To learn more about one energy prospect with plenty of potential, read the Fool's special free report on energy. Inside, you'll not only find out its name but also discover why its stock could soar. The report is free but only available for a limited time, so click here today.