Natural Gas ETF Protects Self, Not Investors

WILLIAMSTOWN, MASS. (TheStreet.com) -- The refusal of the U.S. Natural Gas ETF(UNG) to issue additional shares is not enough to protect investors. The latest decision from UNG managers is a move to protect the best interests of the fund. Investors should avoid UNG for the foreseeable future until the dust settles.

UNG's rejection of the additional approved units is a significant, if unsurprising, move in an ongoing saga. In early July, fund managers "ran out" of the pre-approved share allotment, forcing a halt in share creation. This jolt disconnected UNG's market price from its net asset value (NAV), forcing the fund to break one of the most important promises made by the ETF industry.

Managers of the fund filed with the SEC for an additional 1 billion shares while the fund itself spent much of July trading at a marked premium. During this period, the Commodities Futures Trading Commission (CFTC) began to examine the role that indexing strategies like UNG had in the futures markets for commodities like natural gas.

Sensing that regulation was imminent, managers of UNG began to decrease their position in natural gas contracts and reallocated funds to the purchase of swaps. These swaps trade over the counter and would not be subject to the same regulations as futures trading on the New York Mercantile Exchange.

This restructuring of UNG has changed the essence of the fund. The halt of the creation process has broken the tie between NAV and market price, but the change to swaps alters the nature of the fund entirely. The fund's website asserts that UNG's objective is to track "changes in percentage terms of the price of natural gas delivered at the Henry Hub, Louisiana, as measured by the changes in the price of the futures contract on natural gas traded on the New York Mercantile Exchange."