A few months ago, I urged caution on the United States Natural Gas Fund, LP ETF (NYSEARCA:UNG), as the U.S. experienced an unusually warm winter and seasonality was not favorable until the spring. The UNG ETF is not a buy-and-hold investment vehicle due to the negative futures roll decay of the product.
Since my article was published, the UNG ETF has fallen by over 60%, justifying my caution (Figure 1).
As winter turns into spring and hope springs eternal, is now the time investors should consider trading natural gas through the UNG ETF?
Do Not Buy And Hold
First, as a reminder, the UNG ETF is not a buy and hold investment vehicle, as it holds front month natural gas futures and must roll them upon expiry. For example, the UNG ETF currently holds $1.0 billion worth of May 2023 futures (Figure 2).
As these futures expire, the fund must "roll" its position by selling the May futures and buying the June futures. Since commodity futures are commonly in "contango," this "roll" will result in a loss for the fund (for example at current prices, the UNG ETF will have to sell the May futures at $2.23 and buy the June futures at $2.41) (Figure 3).
The result of UNG's monthly roll is an incredible loss of value if the UNG ETF is held over long periods of time. The UNG has delivered -9.4% p.a. over 5 years and -15.4% p.a. over 10 years. If an investor had bought $100 worth of UNG when it was first launched in 2007, he/she would be left with $0.89 at the end of 2022 (Figure 4)!
Casino-Like Returns Draw In The Crowd
However, like any good casino, what draws in the crowds are the tales of fortunes made. In the example of UNG ETF, it raced to a 170% YTD gain in August 2022, on the back of rapidly rising natural gas prices due to the Russia/Ukraine war (Figure 5).
With prices having collapsed by ~80% since August 2022 and spot natural gas trading around $2 / MMBtu, many speculators have been trying to catch the proverbial "falling knife," and trading volumes on the UNG ETF have exploded 3x.
Natural Gas Exhibits Strong Seasonality
Unfortunately, speculators appear to have bought into the hole, as natural gas prices kept falling. The main reason was because of natural gas' strong seasonality patterns.
Simplistically, speculators bid up natural gas prices (measured as Henry Hub gas prices) from September to November, as there is uncertainty around winter heating demand. However, by December, winter storage levels are known, and gas prices start to decline into spring, as actual gas demand is realized.
Natural gas prices tend to stay depressed until April, when speculators once again get worked up about upcoming summer heating demand. This speculation lasts from April to June. By June, summer gas storage levels are known and gas prices decline into the fall, as actual gas demand is realized.
And the cycle repeats.
As we are in the middle of April, seasonality is looking up for spot natural gas prices.
End Of La Niña May Bring Warmer Temperatures
According to the National Weather Services' latest El Niño Southern oscillation ("ENSO") Diagnostic Discussion, "La Niña has ended and ENSO-neutral conditions are expected to continue through the Northern Hemisphere spring and early summer 2023." There is also a chance of "El Niño forming during summer 2023 and persisting through the fall." As a reminder, El Niño tends to cause areas in northern U.S. and Canada to be dryer and warmer than usual (Figure 7).
If El Niño were to form this summer, then that could cause warmer than usual temperatures and result in additional natural gas cooling demand.
Will Europe Get Lucky Again?
Due to an unusually warm winter, Europe largely avoided the natural gas shortage that many pundits were forecasting, with Dutch TTF gas prices falling by over 85% from their peaks in August (Figure 8).
However, looking forward, will Europe be lucky again in 2023?
According to the IEA, 2023 could be an even tougher test for Europe. Russian natural gas supplies are set to fall further in 2023, and could even drop to zero due to geopolitical tensions.
While Europe had been buying LNG on the spot market to backfill supply in 2022, LNG markets will be tighter in 2023 with the return of Chinese import demand, as China re-opens its economy after COVID lockdowns.
Finally, it is estimated that the mild autumn and winter contributed to a reduction in demand by 10Bcf. There is no guarantee that temperatures will be mild in the coming year.
The IEA estimates that there is a 27 Bcf gap between supply and demand that will need to be closed for 2023. This could put upward pressures on global natural gas prices as Europe begins to store natural gas in the second half of the year.
Technical Rebound Shaping
For those adventurous, there is a technical rebound shaping in spot natural gas prices, with the PPO oscillator forming a mechanical buy signal with positive divergence against price (Figure 9).
A similar pattern can be seen in the UNG ETF's price action, which mirrors the spot natural gas prices above (Figure 10).
For speculators, a trade could be ventured here on the UNG ETF with stop loss set near recent lows, playing for a rebound in natural gas prices to $3.00 or more.
Conclusion
The United States Natural Gas Fund, LP ETF is a casino built on volatile natural gas prices. For those adventurous types, I believe a technical rebound in the UNG ETF is shaping, built upon positive seasonality and the potential for an El Niño to develop in the summer, which could push up cooling demand. Finally, Europe has a large natural gas shortfall that will need to be filled either with demand cuts or additional imports of LNG. I rate United States Natural Gas Fund, LP ETF a Speculative Buy for a trade into the summer.
Macrotips Trading
Author of the Macro Trends & Inflection Points Newsletter. I spent 5 years as a co-founder and hedge fund CIO / manager. Before that, I was a hedge fund analyst/portfolio manager at a leading Canadian alternative asset manager. I write articles as part of my own due diligence on the stocks that I find interesting.Follow my twitter or substack for my thoughts on the macro trends.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in UNG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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