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Natural Gas Fund's Impact on Futures Prices Debated

The natural gas futures market was abuzz last week over an analyst's comments that growth in the United States Natural Gas Fund (UNG) might be responsible for the rebound in prices over the last month despite the lack of supportive fundamentals. While some analysts were claiming that the exchange-traded fund (ETF) might be cornering the market because it allegedly is holding title to as much as 80% of the June contract's open interest on the New York Mercantile Exchange (Nymex), other analysts and traders were less convinced the story, and/or the percentage, could be true.

The nondiversified UNG fund bills itself as an investment vehicle that seeks to replicate the performance, net of expenses, of natural gas. The trust is set up so that it may invest in near-month natural gas futures contracts on Nymex.

Natural gas futures open interest and total volume levels have been down the last few months, but traders have seen a rebound in activity in May, which corresponds with the two week rally in the prompt-month futures contract. After bottoming out at $3.155 back on April 27, prompt-month futures ran up to a high of $4.575 last Wednesday before closing Friday at $4.098.

"I wouldn't rule out that the UNG fund had something to do with the recent rally in natural gas futures, because the bullish fundamentals are not there to support the move," said Steve Blair, a broker with Rafferty Technical Research in New York. "I've been saying that this price hike has to be the result of some fund money coming back into commodities. The equities have been up, so people are taking some of those gains and moving into commodities."

Blair said if futures break below the important support zone at the $3.980 to $4.020 level, it would prove that this upward move was fund-driven and not fueled by anything of a fundamental nature.

"My problem with the analyst piece is that it made it appear that the UNG fund was having an undue amount of influence on natural gas futures," said Addison Armstrong, director of Market Research with Tradition Energy in Connecticut. "The piece overstated the case because it made it appear that 80% of the open interest in the front-month contract was held by this fund, which there is no way that could actually be true. That said, nobody can ignore the fact that the UNG fund is becoming a much talked about factor in the daily movements of the price of the underlying futures contract. Currently the fund holds somewhere between 25-30% of the open interest in the front-month futures and swaps."

News of the fund's large open interest grab had other market participants talking about position limits. "I've read that there is speculation that UNG might be holding a large majority of the June gas contract's open interest, but I find it really hard to believe, especially the 80% figure that is being tossed around out there, because position limits would be a problem," said a New York energy trader. "I've heard that ETFs in crude oil were allowed to trade over position limits. Somehow they got classified as a commercial trader and I can't believe it. You can't hold 80% of the open interest in a contract month without being over the 12,000 position limit, so either the math is wrong or something fishy is going on here."

A Washington, DC-based broker noted that natural gas would be an easier market to dominate than crude, but he was also unconvinced that the UNG story was true. "A fund could get a bigger percentage of the open interest in natural gas than crude because crude is a much bigger contract and there are a lot more physical players," he said. "It could be possible, but I don't know in this instance.

"We have already begun rolling out of June/July gas futures and June and July combined have about 190,000 open interest, so 80% of even just the front month would be well over the 12,000 position limit. If UNG does hold a significant amount of the open interest, then it needs to be looked into so it doesn't cause a disruption in the market if someone tries to take advantage of their rolling of contracts."

The broker noted that the UNG rumors read similar to the ones from a few months ago about the United States Oil Fund (USO). "There was talk that the Chicago Mercantile Exchange [CME] went and talked to the USO fund and informed them that they were going to be picked alive by the hedge funds if they did not change the way they do things," he said. "Apparently USO used to write the rules in their prospectus of when they roll and what they roll from and into. CME told them since they had large positions, everyone was going to front-run them, so they needed to camouflage their actions a bit."

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