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GAZ Follows UNG's Lead In Suspending New Shares

In what appears to be yet another victory for the Commodities Futures Trading Commission (CFTC) in its efforts to curb speculative trading activity in the energy commodities markets, Barclays Bank plc announced Aug. 21 that it will temporarily suspend all additional issuances of its iPath Dow Jones-UBS Natural Gas Subindex Total Return Exchange Traded Notes (GAZ) until further notice. The bank chose to halt new share issuances "in light of current market dynamics and ongoing regulatory review."

The move comes on the heels of the Aug. 12 decision by the United States Natural Gas Fund (UNG) to stop issuing limited partnership units of its own fund, because of impending speculative position limits in commodity futures contracts and expected increased regulation of over-the-counter derivatives. UNG made that decision despite being awarded the ability by the Securities and Exchange Commission to award up to 1 billion new partnership units (see NGI, Aug. 17).

Unlike UNG, GAZ does not hold any actual futures contracts, but that does not mean the fund has no potential influence on natural gas prices. The fund is exposed to high amount of natural gas price risk, because the principal value of the underlying debt securities upon which shares of GAZ are traded are indexed to price changes in the near month Nymex natural gas futures contract. As natural gas prices rise, so too does Barclays' ultimate financial obligation to its GAZ shareholders. Barclays likely attempts to hedge that risk via the swaps market, which in turn will cause swap dealers to hedge their own risk by increasing their purchases of natural gas futures contracts (see NGI, Aug. 10).

An analyst speculated that Barclays may be concerned that a swap dealer will no longer be given a hedger's exemption to hold as many futures contracts as necessary to counter its own swaps risk, especially since the bank announced "the factors underlying the temporary suspension of the notes may impact other commodity-linked iPath ETNs in the future." The CFTC is expected to rule on whether to continue the hedgers exemption to swap dealers later this fall.

Investor interest in GAZ has surged in the last six weeks. Since UNG originally announced it had run out of new limited partnership units it could issue to the public on July 8, the number of outstanding shares of GAZ has more than doubled, rising to 14 million shares as of the close of trading on Aug. 20. Barclays issued more than five million of those new shares in the week following UNG's declaration it would not issue any of its new one billion unit allotment.

A New York analyst speculated that a primary reason for the recent rise in the GAZ share count is that some traders are trying to take advantage of the premium in UNG's unit price over its net asset value. "UNG has essentially become a closed end fund since its stopped issuing shares, which has pushed its unit price well above the value of the natural gas securities it holds," he told NGI.

UNG closed Thursday (Aug. 27) trading at a 16.4% premium to its net asset value. "I think smart investors have been shorting units of UNG, and buying shares of GAZ, in the hopes of profiting from that spread. Both UNG and GAZ try to mimic the moves of the front month Nymex natural gas contract, and their daily price movements tend to be similar. So GAZ has become an excellent substitute for UNG, at least from a price standpoint," the analyst explained.

In the days since GAZ stopped issuing new shares, the fund has started trading at a significant premium to its own underlying value. GAZ typically traded at no more than a 2% premium or discount to the Dow Jones-UBS Natural Gas Total Return subindex, but since Barclays stopped issuing new shares on Aug. 21, the fund surged to an 11.8% premium on Tuesday (Aug. 25) before settling back to 7.9% after the Thursday close.

That premium rose from just 0.8% on Aug. 19 to 5.5% on August 20, and the analyst believes that sudden rise may have been a major factor in the timing of Barclays' decision to stop issuing shares that very next day.

Barclays gave no indication of if and when it would resume issuing new GAZ shares.

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