Natural Gas ETF 'Taxed' by Delay

Picture a UNG approved market maker as a kid who wants to have a lemonade stand. On his first day, he will mix up a batch of lemonade after he anticipates how much lemonade he will sell. He will probably consider factors like the weather and how busy his street is. As awareness of the lemonade business grows and demand increases, he will have to make bigger and bigger batches each day to meet demand if he doesn't want to raise the price.

UNG has become like a lemonade stand on a super highway of demand. In anticipation of the volume that the fund would generate each day, designated market makers have had to make bigger and bigger batches of the fund. On July 7, the SEC cut off the supply of lemonade. In a regulatory filing issued last Tuesday, UNG had to suspend issuing new shares while it waits to see if it can create 1 billion new units. UNG had originally been approved to create 200 million units.

In the meantime, investors are still thirsty for shares of UNG, driving the price of the existing UNG shares above their NAV. While some investors may not care about the price increase and just want to get into the fund, it is important to understand that this method of pricing runs against the "spirit" of ETFs. The eventual approval of more units is very likely, and this move will drop the price of UNG until it is back in line with NAV.