Before 2009, the natural gas market was largely unaware of the existence of the single-commodity exchange-traded fund (ETF), called United States Natural Gas (UNG). But the sizeable positions held by this fund, which have a significant effect on gas prices, are increasingly drawing attention, says Teri Viswanath, director, Credit Suisse.

Recently, nontraditional investors’ (managers of stock and bond portfolios, individual investors, etc.) interest in commodities has intensified, causing an accompanying increase in investment-product offerings. At one time, these investors favored passive exposure to commodities as an asset class for portfolio diversification.

Now, the trend is for these investors to take active, directional views on individual commodities, including gas.

“In the early days of commodity investing, it was generally believed that the real benefit of exposure to this asset class was that the income stream from commodities would offset losses from stocks and bonds during periods of unexpected inflation,” says Viswanath. “As a ‘real’ asset, commodities provided these investors with a noncorrelated investment that tended to perform well during inflationary periods.”

During the 1990s, an array of index products emerged to provide nontraditional commodity investors with diversified, long-term, passive exposure to commodities. These instruments were primarily packaged as over-the-counter swaps or structured notes and were targeted to institutional investors.

Later in the decade, a few commodity-index mutual funds were offered to individual investors seeking to add commodity diversification to their investment portfolios.

“By and large, the benefits of these early commodity investments were that they provided investors with exposure to a wide array of commodity markets, including gas, with limited upfront investment and without the risk of physical delivery,” says Vis­wanath.

“The conventional commodity-index investments were based on a basket of commodity futures that would mechanically roll to maintain a continuous investment in each commodity. Investments made in these index products were predicated upon long-term, passive, buy-and-hold commodity strategies.”

Growing awareness of commodities and the rapid rise in commodity prices have fueled a product evolution this decade, she says, enabling investors to take active views on individual commodity markets while still maintaining the core benefits of those earlier commodity products, such as limited upfront investment and the absence of delivery risk.

In 2006, the first U.S. crude oil ETF, the U.S. Oil Fund LP (USO), was launched, followed in 2007 by the natural gas ETF, UNG.

“With financial industry estimates now pegging the investor market in commodities somewhere in the $100- to $150-billion range, nearly quadruple the level of investment a decade ago, it is perhaps not too surprising that natural gas has become a market of interest for these investors,” says Viswanth. “However, from a market-timing perspective, it seems peculiar that investors emerged this season.”

A wave of UNG purchases in May occurred in the absence of natural gas short sellers in the market, creating a sort of self-fulfilling prophesy. UNG buyers may have been purchasing shares on the belief that the price of gas would rise and cause it to gain ground from the lows set in April. During June, even the surge of investors into UNG failed to lift prices above $4.50.

“We believe one of the primary reasons the market was unable to rally above market highs set in May was that there were a number of producers that began to add hedges in June in order to capture the improvement in the curve. A temporary restriction preventing UNG from issuing additional units, and subsequently purchasing incremental contracts of natural gas, means that the season’s most important buyer has stepped to the sideline.

“The vacuum created by UNG’s absence in the gas market seems likely to lead to continued pressure on prices,” she says.

These new single-security commodity investments comprise some 10% to 15% of the overall investor market for commodities now, she says. Among these newly minted products, USO has enjoyed the market-leader position until most recently, when UNG emerged as the leader.