The UNG is Heating Up

Published on Thursday, 07 January 2010 00:19 Written by Gerard Lerod

New York, Jan 7^th (TradersHuddle.com) – The United States Natural Gas Fund ETF (NYSE:UNG) has been nothing more than a widow maker during the entire 2009 period. This fund has been haunted with multiple issues regarding the commodity it is supposed to be tracking.

For the most part (some precious metals funds are exceptions), commodity exchange-traded products don’t buy or store the physical commodities with which they are associated, and the UNG is not different at all. The UNG use a futures-based strategy to gain exposure, investing in exchange-traded futures contracts that generally maintain a strong correlation with movements in the spot price of the underlying assets.

However, the correlation is far from perfect. Returns to a futures-based investment strategy depend on several factors, of which we can highlight the changes in the price of the natural gas, the ‘roll yield, and the interest for the collateral for the futures contracts. If the futures market enters contango where the near month contracts cost less than the far month contracts, reflecting both market expectations of a rise in price and any costs associated with storage and transportation.

Given the UNG doesn’t want to actually take possession of the natural gas underlying its futures contracts, it “rolls” its holdings on a monthly basis, selling near month futures and buying up second-month futures. In the current environment, if UNG sold 100 contracts for January delivery for $4.53, it would receive enough proceeds to buy only about 98 contracts at $4.62.

Understanding the contango and why the UNG is not able to appropriately track the price of natural gas is important for traders looking to establish a position in this or in any other commodity ETFs, which continue to be the best way for retail investors to get exposure to the underlying commodity.

Aside from the underlying tracking of the commodity the UNG has become a trading instrument, and we can measure this with the increase in volume that has started to flow into the stock since last summer.

Technically the UNG looks strong with what appears to be a double bottom set just below the $9 level, after this the UNG has been able to rally and so far hold the 50 day moving average basing and consolidating between $11 and $10.

TradersHuddle’s peaks and troughs algorithm is setting its support level for the UNG at $10 and resistance at $10.86

A break of resistance can push the UNG towards $12.50 that happens to coincide with the 200 day simple moving average; with the nasty cold weather hitting a big piece of the country might push the spot contracts just enough that could result in a good momentum push in the UNG stock price.