Value in Natural Gas Sector for a Trade?
Make no mistake, the broad markets are in a melt-up phase and there is very little value in most sectors. This is not likely because we are about to embark on a strong period of economic growth or even that trade tensions have cooled. This is mostly about fear of missing out. Even the most defensive sectors, because of their less cyclical economic risks, are very expensive. Utilities are trading at huge valuations because so many desire their relatively stable dividends.
Jumping up on our value screen today is the natural gas sector. To say it’s been a difficult decade would be a gross understatement. The US led fracking revolution has in terms of new supply and new LNG distribution has at times been very bullish and bearish over the past few years. One major overhang for the sector is clearly the shift towards more ESG (Environmental, Social, Governance) theme in investing decisions and the tie to climate change. This will most likely remain a major headwind and the longer-term outlook is not great.
UNG is an ETF linked to the front month natural gas futures contract and it’s decline since inception speaks to the difficulties of investing in commodity markets. Futures markets trade with an expectations of what the future price will be and if the future price does not equal the spot price when the contract comes due, there is in most cases a loss in value. It can be more than 1% per month. The more volatile a commodity is (Nat Gas is one of the most volatile) the worse this impact is on long-term investment. For most of the past 10 years, the front month price has bounce between $2 and $4 with occasional spikes, but the forward markets that UNG tracks have been in constant price decay. With front month nat gas below $2, we are back at a place where there is some long-term value and the question is what is the best way to invest?
The answer is similar to what I’ve said for the energy sector. It may no longer be investible given climate change due to the trend over the next 30 years to massively reduce the world’s carbon footprint. The difference of course with nat gas, is that its (carbon) footprint is about half of coal. And perhaps for the next decade or two, we should see more coal generation retired and more nat gas come on. Of course, it’s probably not a long-term solution compared to cleaner renewables.
Regular viewers might recall that I was shorting the spike above $4 in late 2018 by selling calls that had huge premiums, so I’m by no means a bull on the sector. For the options players out there, look at selling two units of a UNG June 14 put and buying one unit of a June 17 call for a net credit (meaning you get paid to wait). For the yield generators, you can pick up 3-6% yield in the coming months with volatility premiums rising on the current selloff buy writing naked puts while you wait to buy. Trading commodities for shorter periods (a few months) does not have the same long-term buy and hold risks noted.
So long-term investors are far better playing exposure to nat gas weighted E&P companies that pay dividends versus the pure commodity. The two nat gas equity based ETFs are ZJG.to and FCG.n. Both have been around for a decade or more. Here too, however, the trends over time are UGLY! For us it’s time to buy dips in the sector and pick up a little exposure. Not because we love the long-term outlook, but the potential for a tradable rally in a beaten up sector offers the attractive valuations and return to risk profile we like in our positions versus the vast majority of money today that is chasing a fear of missing out.
Our spring roadshow will focus on how to incorporate ESG investing into your portfolio. Next week we will be live from Florida at the ETF.com conference where the theme will be on ESG investing.