How To Invest in Natural Gas Using Commodity ETFs

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How To Invest in Natural Gas

Until recently, the average investor has strained to discover how to invest in natural gas directly. Buying futures on the commodities market is both a complicated and expensive prospect, and very few small-cap investors have the resources or connections to do it. Fortunately, commodities-based ETFs have come along to fill that demand.

ETFs, or exchange-traded funds, are the progeny of mutual funds. Unlike mutual funds, however, they are priced in real-time rather than at the end of the day, making trading determinations much easier (and less vulnerable to institutional chicanery).

Several natural-gas based ETFs have emerged in recent years, each using slightly different criteria and portfolios.

The most widely-traded natural gas ETF is the United States Natural Gas Fund LP (UNG). This fund holds monthly futures contracts on U.S. natural gas assets, allowing the fund to accurately reflect the current spot price of natural gas (rather than a long-term projection of same).

UNG is up 15.85% in the past 52 weeks and up 18.70% in 2014 as of March 25. Over the same 52-week period, natural gas futures jumped 25% from $3.50 to $4.38. This fund, while underperforming actual natural gas futures (as all LNG ETFs do because of management and rollover costs) significantly outperforms its leading competitors. The more current asset portfolio, as well as smarter fund management, is largely the cause of this fund's meteoric rise to the top of the natural gas ETF pool.

The next most popular natural gas ETF is actually an inverse ETF, meaning that investing in it will yield profits only if the spot price of natural gas drops. This fund, obviously, has performed quite poorly in the past 52 weeks. Oddly, however, it has lost far more in percentage terms than the natural gas market has gained (-71.68% v. +25%).

This is indicative of the danger of trading inverse ETFs; while they may be an advisable strategy for hedging against crashes in the equities market, they can be extremely volatile when pegged to one commodity. Therefore, we cannot recommend investing in this fund except with the utmost caution and understanding of the inherent risks.

United States 12 Month Natural Gas Fund (UNL) is an example of a more traditional long fund, comprised entirely of 12-month US natural gas contracts.

While this fund's 52-week upside performance (5.49%) is pitiful compared to the overall market, it is far more stable than a monthly fund like UNG. Though UNG doesn't rack up the impressive short-term gains of more volatile options, it also doesn't suffer under the vicissitudes of a rapidly-shifting market. Small-cap investors wondering how to invest in natural gas should seriously consider this well-capitalized, solvent fund.

The DJ-UBS Natural Gas Subindex Total Return ETN (GAZ) is a compromise between short-term and long-term funds. It is managed by Barclays iPath and is essentially an entry into the NYMEX natural gas market.

It currently holds the Henry Hub natural gas futures contract, which is traded daily on worldwide commodities exchanges. While the fund itself rolls over annually, the price is directly correlated to the spot price on the NYMEX. This allows for larger short-term gains (7.5% in the past 52 weeks) with less long-term volatility and fewer costs than a fund that rolls over monthly.

There are myriad other options available; these are merely the highest-capitalized and most popular funds. But if you've been wondering how to invest in natural gas, yet have been daunted by the prospect of entering the commodities market directly, one or more of the foregoing funds deserve your attention.

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