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Nat-Gas Plays You Need to Know About Now

Dan Caplinger
June 15, 2012

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 N