Please Don’t Ever Buy this ETF

I'm not a huge fan of Exchange Traded Funds (ETFs) in general. I believe most investors think ETFs are just set-it and forget-it type vehicles that magically turn the idea of diversification and sector allocation into profitability.

But if you have any interest in success, you must MUST do your homework on ETFs – just as you would for any stock, bond or anything you want to buy.

There aren't any shortcuts in the investing world. ETFs aren't automatically safer than regular stocks. They're not a magic bullet. Many ETF managers would love you to believe otherwise, but ETFs follow the same rules of any other investment, and deserve your full analytical attention.

Don't misunderstand me: I think ETFs can be a great tool for investors. We run a very successful ETF service here at Wyatt Investment Research called ETF Master Portfolio. I recommend checking it out if you have any interest in ETFs.

But I feel like it's my duty to warn investors away from considering an investment in most ETFs.

In many cases, there are better single stock opportunities in a given sector. Or there are better opportunities in mutual funds or even certain bonds.

But in some cases, buying an ETF can be one of the worst mistakes you'll ever make.

I've written about one ETF in particular on several occasions, but it's one of the worst offenders in the market. So it bears repeating. I could write about how lousy this ETF is on a monthly basis and it wouldn't be enough.

I know many investors have been tricked into thinking the United States Natural Gas fund (NYSE: UNG) is designed to closely track the price of natural gas.

But it's not.

And I can see why many investors might be fooled into believing this ETF will be profitable if natural gas rises in price. On the face of it, you'd think to yourself, "Oh wow – natural gas prices are really low right now. I should buy something in the sector."

Then you'd do a google search, or maybe snoop around in your online brokerage for something "safe" – like an ETF! So you'd search for "natural gas ETF" and the results would be dominated by UNG.

There are even some "analysts" out there who have been touting UNG. You might stumble onto one of their articles. And there are dozens if not hundreds of news blogs that simply parrot the advice from the analysts, so odds are, you won't find the handful of anti-UNG pieces I've written.

You'll find lots of second-hand evidence that UNG is designed to track the price of natural gas.

And you'll buy it – because after all, natural gas is cheap.

It's super cheap! Even if you're wrong on the timing, UNG will stay flat. Maybe it will dip a little. But eventually natural gas prices will rise.

But that's not how it works. UNG is not designed to track the price of natural gas.

It's designed to hold natural gas futures contracts and sell them into expiration, rolling those funds into more futures contracts that will expire in the coming months.

Since natural gas is almost always in somewhat significant contango (meaning, futures prices are more expensive the further out you are from expiration) this fund loses money every month – unless natural gas spikes dramatically in price in short order.

So the only way you'll make money is if something out of the ordinary happens – in other words, you'd only buy this fund if you think you can predict an unforeseen event with a great deal of accuracy.

Not exactly a sound investment strategy.

And we've seen how poorly this strategy has played out for UNG. Below, I've posted a chart of natural gas price performance vs. UNG price performance.

UNG long term chart

Now, admittedly, natural gas hasn't done very well in the past 2 years. It's down 25% – but UNG is down over 60% over the same period. So it more than doubled the losses of natural gas.

A longer term chart of UNG shows an even more abysmal track record.

natural gas price performance vs. UNG price performance

Since it launched in mid-2007, UNG has only been in positive territory for a few months during the dizzying heights of the oil and gas bull market of 2008.

Natural gas soared to $15 per thousand cubic feet (MCF) – an all time record high, and a near double in just 7 months. Meanwhile, UNG only moved about 45% peak to trough.

So to recap: UNG seems to double losses in natural gas, and can only match half of the gains during the biggest bull market in modern history.

To be completely honest, I think UNG's managers should be ashamed. I don't think they're doing anything illegal, but selling this fund to people is certainly unethical.

They're happy to collect their 0.6% in fees every year, I'm sure, but you think for the fees you pay, that the fund managers would actually manage UNG so that it makes money when natural gas prices rise.

Really though, this fund and others like it are just indicative of the kinds of people who invest. If everyone did the proper research, funds like UNG would not exist.

Good investing,

Kevin McElroy
Resource Prospector

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