Another exchange-traded note or ETN has fallen off the cliff, taking unsuspecting investors and traders right along with it.
This time it was the iPath DJ-UBS Natural Gas ETN (NYSEArca: GAZ), which has declined more than 50% in value since its March 19 closing price of $6.02.
GAZ was designed to closely follow natural gas futures contracts, but it’s been way off course.
Although GAZ now trades at a ridiculous 56% premium to its underlying assets, it once traded at 134% premium to the value of its natural gas benchmark.
What’s going on?
In August 2009, Barclays stopped issuing new GAZ shares, which the company acknowledged could cause the ETN to trade at a premium or discount in relation to the note’s indicative value. As a result, GAZ shares began to trade higher in value, far above their indicative value.
These distortions in an ETN’s share price and the value its underlying assets is a serious product flaw that has long plagued closed-end mutual funds. Other ETNs linked to S&P 500 VIX futures (NYSEArca: TVIX) have had similar operational problems.
Premiums and discounts can also occur with ETFs, but are usually smaller and less frequent with heavily traded funds like SPDR S&P 500 (NYSEArca: SPY) and PowerShares Nasdaq-100 (NasdaqGM: QQQ).
Some ETN providers will stop issuing new shares in a note to avoid exceeding futures contracts limits. But with just $36 million in assets, it doesn’t appear GAZ positions in natural gas futures were ever large enough to cause such concerns.
For now, both GAZ’s share price and its premium are decompressing faster than a hot air balloon.
What should investors do?
I have been warning investors and traders at ETFguide.com and on my weekly radio program to absolutely avoid ALL ETNs.
On September 13, 2011, I wrote "ETN Market Primed for Disaster." The article was published at ETFguide.com and Yahoo Finance.
That piece was followed up by another controversial article I wrote on November 30, 2011 titled “Are you ready for the Great ETN Meltdown?” Then again, on February 13, 2012, I followed up with “Credit exposure for ETNs not going away.”
In each case, both myself and ETFguide was ridiculed for its forceful recommendations against ETNs.
In the December 2011 edition of the ETF Profit Strategy Newsletter, we asked “Which ETNs Will Blow Up First?” In this research piece, I provided a list of the top 15 ETNs by assets and 15 alternatives. We gave our subscribers three-months of advanced warning, which shows that fiercely independent research and going against the Wall Street consensus is a winning formula.
Today, there’s roughly $17 billion parked in U.S. listed ETNs, which is almost double the amount that was invested in ETNs in 2010. People have piled into ETNs linked to master-limited partnerships (NYSEArca: AMJ), Indian stocks (NYSEArca: INP), and gold (NYSEArca: DGP).
After the sudden meltdown of major financial institutions during the 2008-09 financial crisis, one would logically think that people learned about the danger of credit backed products, but apparently not.