United States Natural Gas Fund: The Time To Buy Is Now (NYSEARCA:UNG) - Seeking Alpha

United States Natural Gas Fund: The Time To Buy Is Now (NYSEARCA:UNG) | Seeking Alpha

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Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.

- Sir John Templeton

Introduction

Generally, it is a very poor idea to own the United States Natural Gas Fund (NYSEARCA: UNG), which holds front month natural gas futures, as an investment.

Why?

Normally, natural gas prices are in contango, not backwardation, meaning the front month futures contract is lower priced than the next month further out, and so forth. Thus, most of the time the United States Natural Gas Fund has to roll their contracts from month-to-month, and natural gas futures are in contango, then the United States Natural Gas Fund ( UNG) is absorbing a loss from the negative roll yield.

More specifically, if you are a shareholder, you are absorbing a loss as the United States Natural Gas Fund rolls its underlying natural gas futures contracts. Making matters worse, the institutional marketplace of investors is aware of when the United States Natural Gas Fund and the ProShares Ultra Bloomberg Natural Gas ETF ( BOIL) roll their contracts, as the roll dates are published. Thus, you can imagine how those in the futures pits (or futures screens) maneuver around these whales trading huge positions. Said another way, their trading is an easy target, as the roll dates are pre-determined.

At the end of the day, the United States Natural Gas Fund is a horrible investment for long-term holders, and for those who can trade natural gas futures ( NG1:COM) directly, this is generally a better choice. Having said this, many market participants do not trade natural gas futures directly because it is different from stock trading, the margin and leverage requirements are different, and these aforementioned funds package the futures for you into a nice, easy to trade vehicle.

Longer-term performance of the United States Natural Gas Fund, as you can imagine from the opening tone of this article, has been abysmal, so an investor should be very reluctant to own this investment vehicle, except on rare occasions. Given that natural gas spot prices are near all-time lows, I believe that now is one of those rare occasions, similar to 2022, except better with a longer runway, to be long the United States Natural Gas Fund.

Longer-Term Performance Is Abysmal

No doubt about it, you do not want to be a longer-term shareholder of the United States Natural Gas Fund.

Long-Term UNG Chart (Author, StockCharts)

Looking at the chart above, professional investors have made a fortune knowing the reality of the drag of the negative roll yield of contango futures.

However, there are exceptions, where the United States Natural Gas Fund actually goes up more than natural gas spot futures prices. The first nine months of 2022 was one of those rare exceptions because we saw backwardation in natural gas futures, albeit only briefly.

UNG Versus Spot Natural Gas Prices First Nine Months Of 2022 (Author, StockCharts)

Believe it or not, we actually had a brief period of backwardation in natural gas futures earlier in 2024, and UNG is outperforming again year-to-date, albeit just losing less in this case.

UNG Versus Spot Natural Gas YTD (Author, StockCharts)

While natural gas prices have gotten clobbered in calendar year 2023, and YTD in 2024, the brief spike into backwardation showed that the weather independent supply/demand fundamentals may be tighter than many investors believe at the current juncture. In summary, don't let the historically warm winter weather of 2023-2024 blind your eyes to a developing structural demand/supply imbalance as a wave of new LNG export facilities finally starts to arrive later in 2024 and into 2025.

Probable LNG Export Capacity (Raymond James, EIA)

The initial brief backwardation in natural gas prices earlier in 2024 is the first tell, in my opinion, that we are going into an environment where natural gas will be structurally undersupplied versus demand, and I believe this time frame will last longer than it did in 2022, potentially spanning 2025-2028.

Natural Gas Prices Are Near All-Time Lows

A historically warm winter in 2023-2024 has driven natural gas prices around the world lower, and natural gas prices are near 20-year lows, and within spitting distance of all-time lows in the United States.

Spot Natural Gas Long-Term Prices (Author, StockCharts)

At these low prices, there are all kinds of bullish developments for short-term and intermediate-term natural gas prices, including coal to gas switching, producer restraint, as I mentioned in my recent article on Chesapeake Energy ( CHK), and short covering as those who rode natural gas prices down take profits.

Don't Lose Track Of The Boom Bust Cycle

Storage for natural gas has not really grown that much in the past decade, despite rising demand for natural gas domestically, and strong export demand.

Thus, days of usage in storage is relatively low, and this amplifies and exacerbates the boom/bust cycle in natural gas.

The Wall Street Journal had a good article about this a while back, published on February 11, 2023, and here is a snapshot of the article's headline which has proven beyond prescient.

Snapshot Of February 11th, 2023 WSJ Article On Natural Gas (Author, WSJ)

Further into the aforementioned article, there was a graph of volatility days, and it showed that natural gas price swings were getting bigger, with more frequent 10% price swings in a single day.

Days With 10% Price Swings (EBW Analytics, WSJ)

This pattern of 10% price moves is already playing out in 2024, with a 10% move higher last Wednesday, February 21st.

Why are there increasingly bigger natural gas price swings?

First, in my opinion, is that in structural natural gas bull markets, think 1995 to 2009 in the chart above, there tends to be a bigger number of 10% price moves. Second, there are more speculators attracted to the United States Natural Gas Fund and correspondingly, there are more institutional natural gas short players trading and structurally positioning around the United States Natural Gas Fund. Third, the days of supply is a massive, under discussed issue, and this quote from the WSJ article linked above summarizes the days of storage situation succinctly.

Volatility could get even higher in the coming years, Mr. Rubin notes. The buffers that historically quelled severe swings are getting thinner. While domestic natural-gas consumption rose about 25% between 2011 and 2021 and exports more than tripled, natural-gas storage capacity that ensures adequate supplies in winter hasn't budged. Data from S&P Global Commodity Insights shows that natural-gas prices spiked up a lot more than usual when storage fell below the five-year average.

Source: Eli Rubin (EBW Analytics), WSJ

Bottom line, natural gas prices have experienced the bust part of the cycle in 2023 and the early part of 2024 after the boom cycle of 2021 into late 2022 and the next part of the boom should be next.

In my opinion, we were already positioned to bottom entering the winter of 2023/2024 after exploration and production producer restraint through 2023, evidenced by lower and lower rig counts; however, a historically warm winter has stalled the next phase of the boom.

With winter ending, bearish weather risk is abating, and the underlying, increasingly tight supply/demand fundamentals, driven by producer restraint throughout 2023, should show through.

The risk at this juncture is that the bottoming process could be extended, as there is still runway before the increased LNG exports come online. While this is a risk, once the final months of winter pass, I think this risk will be abated, as most investors will be able to see how structurally tight the longer-term supply/demand fundamentals are right now.

Closing Thoughts: Hold Your Nose, And Reluctantly Buy UNG For A Trade

If natural gas prices get to the $4.50 level that Raymond James ( RJF) estimates they will be in 2025, in their January 19th, 2024 overview, then even with the now built-in contango into the futures curve at the present juncture, the United States Natural Gas Fund should perform well.

Raymond James Forecasts $4.50 dry gas in 2025 (Raymond James)

Adding credence to Raymond James' forecast, as of February 8, 2024, Goldman Sachs ( GS) has a $4.40 2025 price forecast for natural gas prices.

Personally, I think that the busts have been deeper and the booms will be higher, primarily due to the days of storage issue, so I think $4.50 dry gas price forecasts for 2025 are too low.

On this note, looking back to 2020, 2021, and 2022, there were hardly any analysts forecasting the price moves in natural gas that we got in 2021 and 2022, which happened to be a very fertile investment landscape for our investing group.

In fact, a big part of our generational buy series published publicly on Seeking Alpha on Antero Resources ( AR), which can be viewed here, EQT) in the heart of the bear market of 2020.

The added kicker is that much like in 2022 when the market starts to anticipate the surplus in storage falling, and perhaps even heading for a structural deficit as significant new LNG export demand comes online in 2024-2028, then natural gas prices will quickly move to backwardation.

When this happens, and the United States Natural Gas Fund rolls their futures contracts, they will actually have a tailwind, instead of a headwind, and that is why for a large part of 2022, the United States Natural Gas Fund outperformed natural gas spot futures prices. Ironically, the same set-up is in place again, as already demonstrated by the relative outperformance of the United States Natural Gas Fund thus far in 2024, though this is being obfuscated by the historically warm winter weather.

Instead of sulking, enjoy the 60 plus degree days, which is the forecasted temperature in the heart of the Midwest, and prepare for the significant, reluctant, opportunity ahead.

Best of luck to all.

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