Make no mistake, the broad markets are in a melt-up phase and there is very little value in most sectors. This is not because we are about to embark on a strong period of economic growth, or even because trade tensions have cooled. This is mostly about the 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.
On our value screen today is the natural gas sector. To say it’s been a difficult decade would be a gross understatement. The U.S.-led fracking revolution has, in terms of new supply and new LNG distribution, at times been very bullish or very bearish over the past few years. One major overhang for the sector is clearly the shift towards ESG (Environmental, Social, and Governance) investing. This will most likely remain a major headwind.
The United States Natural Gas Fund (UNG) is an exchange-traded fund linked to the front-month natural gas futures contract, and its decline since its inception speaks to the difficulties of investing in commodity markets. Futures markets trade on expectations of what the future price will be. In most cases, if the future price does not equal the spot price when the contract comes due, there is a loss in value that can be more than one per cent per month. The more volatile a commodity is (nat gas is one of the most volatile), the worse this impact is on a long-term investment. For most of the past 10 years, the front-month price has bounce between US$2 and US$4, with occasional spikes, but the forward markets that UNG tracks have been in constant price decay. With front-month nat gas below US$2, we are back to a place where there is some long-term value. 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 as the world moves to massively reduce its carbon footprint over the next 30 years. The difference with nat gas, of course, is that its carbon footprint is about half that of coal’s. 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 US$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 three-to-six-per-cent yield in the coming months, with volatility premiums rising on the current selloff, by 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 off playing exposure to nat-gas-weighted E&P companies that pay dividends versus playing the pure commodity. The two nat-gas equity-based ETFs are the BMO Junior Gas Index ETF (ZJN) and the First Trust Natural Gas ETF (FCG). Both have been around for at least a decade. 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 because the potential for a tradable rally in a beaten-up sector offers attractive valuations and the return-to-risk profile we like in our positions. Meanwhile, the vast majority of money today 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.
Twitter: @LarryBermanETF
LinkedIn: ETF Capital Management
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Website: www.etfcm.com
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