Natural gas prices seem to make the news every few months. You will hear about it during hurricane season, and you saw how Hurricane Katrina affected natural gas prices. You will also read about natural gas when temperature spikes. Whether it’s because of soaring hot temperatures, which means electric companies need to buy more natural gas to generate electricity, or it may be because of a cold snap so consumers are using more natural gas to keep warm.
When these events take place, you will see natural gas prices move quite a bit. An investor or speculator might want to trade this market. There are several ways to trade natural gas. One way would be to trade natural gas futures on the New York Mercantile Exchange. Natural gas futures trading can be very risky. You only have to put up 5% margin in order to trade it. This gives you tremendous leverage, but remember, leverage cuts both ways. If you put up 5% margin and the price of natural gas increases 5%, you’ve doubled your money. On the other hand, if prices decrease 5%, you’ve just been wiped out. Natural gas futures trading can be profitable, but it will take nerves of steel and dedication to following this market.
Another way to trade natural gas would be buying stock in individual natural gas companies. In this case you may be putting all of your money in one basket if you select just 1 or 2 stocks. This will take plenty or research on your part to find the right companies to invest in. Do you want to invest in natural gas exploration and drillers, or do you want to invest in natural gas pipeline owners? Do you only want to invest in natural gas stocks that pay a dividend? These are choices you have to make before investing.
This brings us to natural gas ETFs. ETF stands for exchange traded fund. ETFs have become very popular over the last several years. Not only can you trade a natural gas ETF, but you can find ETFs for other physical commodities too.
You can find a natural gas ETF like the United States Natural Gas Fund, LP, ticker symbol UNG which only trades natural gas futures (more on that later). The UNG fund is very focused and specific on what is in the fund. An example of a fund that will have many stocks and component to it is the SPDR S&P Oil& Gas Exploration & Production Fund, ticker symbol XOP. This energy ETF will invest in the index of stocks of companies that are involved in the production and exploration of natural gas.
Now you may ask yourself why not just invest in a natural gas mutual fund? You certainly can, and there are good ones out there, but you will need to consider a few things before investing.
With mutual funds, you will need to know what stocks are in that fund. Is that mutual fund focused on a specific sector of natural gas, or is it a catch all for anything natural gas related?
What about the expense ratio of a natural gas mutual fund? This is something most investors overlook when buying into a fund. There are some funds that charge over 1% to be in their funds. That can be an enormous drag on your performance. Is there a minimum time to hold that mutual fund? Some mutual fund companies will place restrictions on how often you can move in and out of the fund, while other will charge you a fee if you redeem it in 30 or 60 after first buying into it. They do this to stop investors from day trading the mutual fund, but what if you need to get your money out for an emergency? What about trying to sell your shares during the day? With a mutual fund, you can only buy and sell at the closing net asset value of the stock each night.
ETFs can look like a mutual fund by investing in several different companies in a sector. Where an ETF differ from a mutual fund is in the way you can trade it. No matter which natural gas ETF you invest in, you can trade it like a regular listed stock. You can buy and sell it throughout the day, unlike mutual funds where you can only get one price. ETFs can become a vehicle for day traders. Another advantage of a gas ETF is that you can place stop limit orders on it. If there is news that will adversely affect the price of your ETF, you can place a sell stop order that will immediately liquidate your position when it hits your price. If you invested in a mutual fund, you couldn’t get out until the end of the day. There would be nothing you can do as you watch the value of your natural gas mutual fund erodes.
The United States Natural Gas Fund, LP (UNG)
This is by far the most popular natural gas ETF. This fund invests solely in the front month natural gas futures contract on the New York Mercantile Exchange. The natural gas futures on NYMEX are the mostly widely traded and liquid market for Nat gas futures. This fund will attempt to match the daily price returns of the underlying futures contract. You are essentially trading natural gas future but with a twist. The fund DOES NOT use leverage when investing in futures. This will help protect the fund from wild swings due to leverage. As the month ends, the fund will then start to “roll” out of the front month futures contract before it expires and will “roll” in to the next month futures contract. This is a long only fund. So if you are bullish on natural gas prices, this may be a fund you should look into.