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By Michael Rawson, CFA | 04-04-2012 10:00 AM

Is There a Good Way to Invest in Natural Gas With ETFs?

Value investors interested in taking a position in beaten-down natural gas have to deal with the contango headwind.

 Mike Rawson: Is there a good way to invest in natural gas through an ETF?

Hi there, I am Mike Rawson with Morningstar. Joining me today is Abe Bailin, ETF analyst with Morningstar.

Abe, thanks for joining me.

Abe Bailin: Sure, Mike. Thanks for having me.

Rawson: Natural gas prices are at multi-year lows, while oil prices and gasoline prices are still relatively high. Can you explain this divergence that we're seeing in energy prices?

Bailin: For natural gas, what we've seen is an extremely loose supply side circumstance, and that's going to come on the basis of a number of issues. In the U.S., natural gas is a very regionalized market, and in the U.S. we have a quite a bit of natural gas. Well, over the last several years, within recent history, we've turned to a number of technological advancements, both horizontal drilling as well as new fracking techniques, to allow us to really get a hold of this new supply.

Rawson: OK, so this excess supply has caused natural gas prices to stay low even while oil prices have gone up. This might lead value investors to think, hey, natural prices are cheap, now is a good time to get it in on the bottom floor with natural gas. They might look to do that through an ETF, but your work on natural gas ETFs suggests that that might not be such a good idea. Why is that?

Bailin: In theory, it's a great idea. Natural gas is at historic lows, but unlike some of the more popular commodity ETF products, like say GLD or IAU, where you can actually physically back your holding with the metal, for natural gas, that's not really feasible. You have to either turn to natural gas-related equity securities, so, we'd think nat gas companies or energy companies, or for more targeted exposure, futures contracts.

Rawson: OK, so these natural gas ETFs don't actually own physical natural gas; they might go and own futures contracts?

Bailin: Yes.

Rawson: Now, what's the problem with these futures contracts?

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