Market Pulse: It is important to know what you are buying

INCLINE VILLAGE, Nev. — I was recently interviewed for the June issue of Technical Analysis of Stocks & Commodities magazine. The topic was Exchange-Traded Funds (ETFs). A lot of their questions centered on the new breed of ETFs, such as currency and commodity ETFs, that allow investors to enter markets that were previously only available to professional traders. While these products give investors more flexibility, I find many investors don't fully understand what they are buying. They should.

Let's suppose an investor has watched the price of natural gas plummet these last few years. In a move to buy low, he or she looks to buy a gas ETF. There are a lot of choices. The most popular is U.S. Natural Gas Fund (UNG). Other choices include the Trust Natural Gas (FCG), and iPath Dow Jones-UBS Natural Gas (GAZ). Which one to buy?

It is important to understand what the security tracks. Does it track the futures market or does it track equity prices within the sector? Its performance can greatly vary depending on its holdings. The U.S. Natural Gas Fund (UNG) tracks the futures market while First Trust Natural Gas (FCG) tracks corporate stocks. UNG is down 30 percent this year while FCG is down 9 percent.

Even when two securities track the futures market, their performance can be substantially different. Again, UNG is down 30 percent this year. iPath Dow Jones-UBS Natural Gas (GAZ), which also tracks natural gas futures, is up 2 percent this year. That's a big difference!

One can't just rely on performance though. Little known is that the iPath Dow Jones-UBS Natural Gas (GAZ) has stopped issuing new shares. As a result, this product trades at a huge premium. In fact, it is about double its indicative value. If Barclays, the issuer of GAZ, decides to open the fund again then its shares will plunge.

Another factor to consider is GAZ is an Exchange-Traded Note (ETN) rather than an ETF. As explained in a previous article, ETNs are riskier because they are backed by the credit of the issuing bank or broker. They are only as good as their backer.

The new breed of exotic ETFs allows the everyday investor to enter markets that were previously only available to sophisticated investors. They are complex, however. Before buying these products it is important to fully understand what they are and what they track.

— David Vomund is an Incline Village-based fee-only money manager. Information is found atwww.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.

By David Vomund
Special to the Bonanza

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