BY: NICOLAS PIQUARD, CFA®, VICE-PRESIDENT, PORTFOLIO MANAGER AND OPTIONS STRATEGIST, HORIZONS ETFS
December 7, 2018
For the past several years, it seemed that the easy trade was to go against natural gas. As fracking technology improved over the past decade and natural gas reservoirs were tapped throughout North America, it seemed that the supply was endless. In recent years, hedge funds and other investors have benefited from assuming that prices would remain low.
As can be seen from the chart below, the trend went relentlessly downwards from 2014 until the end of 2017, as measured by Horizons ETFs’ Natural Gas Excess Return Index.
Source: Bloomberg, from December 31, 2013 to December 29, 2017.
Starting in 2018, however, prices started to stabilize as all the bad news and cheap gas production appeared to have already been priced-in. At the same time, demand has been growing as power plants switch to natural gas for power generation.
Source: Bloomberg, from January 1, 2018 to November 30, 2018.
At the end of September, 2018, prices had stabilized for the year, but were stuck in a range. The excess demand was met by more than adequate supply. Eventually though, after over five years of bearish markets, there comes a time when conditions change. For natural gas, that time was November of this year.
When an asset is consistently sold and buyers don’t believe there's any chance that prices will recover, it can lead to very violent swings of volatility. Such was the case for natural gas in October and November, and the catalyst was way colder-than-expected weather and the early onset of winter.
Even as late as August, it seemed that nothing was going to change in the natural gas market. In fact, volatility in natural gas was at a 10-year low earlier this year. Just like the equity markets, natural gas was pricing that the status quo would remain. All of a sudden things changed and the winter season quickly came upon us. That in-and-of-itself shouldn't have been a very big deal. We’ve had colder-than-expected temperatures before and that did not drive the natural gas price much above its historical average.
But no one was expecting gas prices to move given the ample supply available. So when the prices started to move slightly at the beginning of October, it caught everyone by surprise. No one more so than some leveraged funds (which were forced to cover their positions) that started to lose money. As winter temperatures got colder, more and more investors were forced to cover short bets into a rising market. This led to even more buying from short traders. While October saw a steady rise, prices in November resembled more of a panic.
This activity over the past two months has been extremely beneficial to the Horizons Natural Gas Yield ETF (HNY). The rising prices have allowed the ETF to get a total return of 35% between September 28, 2018 and November 28, 2018.
There's also an added benefit: while prices are elevated, volatility has also been elevated – which means we are getting more premiums for our options. In fact, in the last month, volatility was close to a 10-year high, a 180 degree reversal from six months ago.
Source: Bloomberg May 31, 2018 to November 30, 2018.
Me and my colleague, Hans Albrecht, always mention how commodity covered call ETFs are a great way to get exposure to the commodity while getting paid to wait. This current move in natural gas shows how this can work out well for investors.
|Horizons Natural Gas Yield ETF||29.78%||39.37%||37.46%||42.57%||35.89%||3.87%||-9.43%||-7.61%|
* As at November 30, 2018.
** Since inception on February 29, 2012.
The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.