NEW YORK (TheStreet) -- Investors who want to invest in natural gas futures have two choices in the U.S. market: United States Natural Gas (UNG) and the iPath Dow Jones-UBS Natural Gas Total Return Subindex ETN (GAZ).UNG and GAZ offer investors exposure to natural gas futures contracts. Unlike the precious metals, these funds do not store gas, and that has been a sore spot for investors in 2009. Futures contracts cannot be bought and held; they must be "rolled" each time the contract expires. UNG uses a monthly roll strategy whereby it buys the near month contract and then rolls to the next contract before expiration. Investors can go to the Web site of the United States Natural Gas fund and find the roll dates under the "Fund Facts." GAZ is a note that tracks the Dow Jones-UBS Natural Gas Total Return Sub Index. It uses a similar strategy to UNG, but instead of rolling monthly, it rolls bi-monthly. Since GAZ is an ETN, it doesn't list what contracts it owns, if any. Barclays stands behind the notes and is responsible to make payments on the contracts, and a purchaser of GAZ is lending Barclays money the same as other bond holders. Barclays is not restricted in how it can use the capital and investors face the same risk as other holders of Barclays debt. One important difference between UNG and GAZ, besides the credit risk in GAZ, is the tax implications. UNG is a partnership that pays no Federal taxes itself. Gains or losses are passed through to shareholders. Investors receive a Schedule K-1 and may have tax credits or liabilities even if they receive no income payments. GAZ is similar to other stocks in that income payments would be reported on a Form 1099 and capital gains and losses are incurred at the sale. Neither UNG nor GAZ has paid dividends.
Individuals concerned about taxes can consult a professional, as either may be appropriate, given individual circumstances. Investors in tax-sheltered accounts may consider either fund. As for credit risk, it favored UNG until the fund began buying swaps (more below). Now it is a push. UNG charges 0.97% fees and has a three-month average daily volume of 42 million shares. GAZ charges 0.75% and has a three-month average daily volume of 650,000 shares. On this score, GAZ's volume is adequate for all but the largest investors, and the lower fees make it more attractive.
Since futures contracts have an expiration date, it is impossible to buy and hold. Commodity trading strategies take this into consideration and determine which contracts promise the best return. In the case of UNG and GAZ, the funds use a simple strategy that exposes them to gains or losses, depending on where there is backwardation or contango. For instance, say natural gas for October delivery costs $2 and natural gas for November delivery costs $4. If a trader holds 1,000 contracts at $2 and rolls monthly, he will only hold 500 contracts after the roll, assuming no transaction costs. This became a major issue with UNG because it grew to such a large size. When UNG rolls, its selling and buying cause the contango to widen, and since it publicly announces its roll dates, other traders can profit from UNG's "largesse." UNG shareholders suffered losses as they sold at lower prices and bought at higher prices. Currently, contango is especially large, due to several factors, which I have written about previously, and this makes this situation even worse.