Sell GAZ Now: ETN Trades To 119% Premium
April 20, 2012
The massive premium in the iPath Natural Gas ETN (NYSEArca: GAZ) continued to rise this week, with the exchange-traded note trading up to a 119 percent premium above its net asset value. As of 2:32 p.m. ET, GAZ was trading at $3.96/share, while its underlying value is just $1.80/share.
GAZ has been closed for creations for nearly three years, which means that its issuer—iPath—does not regularly create new shares of the note. This breaks the mechanism that usually prevents ETFs and ETNs from trading to significant premiums, because investors chase a fixed supply of shares.
GAZ’s premium has been growing since Jan. 23, rising from near zero to a massive 134 percent on March 19. That premium has been enormously volatile: After hitting the 134 percent peak, it reversed course and fell to “just” 56 percent on March 27, before reversing course again and beginning its recent ascent.
At the current pace, it will approach record levels in a week or two.
GAZ’s premium and discount volatility means the fund’s performance is largely disconnected from the actual market it aims to track—natural gas futures.
In theory, GAZ should trade almost identically to the United States Natural Gas ETF (NYSEArca: UNG), an ETF that provides exposure to roughly the same front-month natural gas futures contract GAZ does. But UNG is not closed to creations, which means it tracks closely to its underlying NAV, as it should.
Since GAZ’s premium began to inflate earlier this year, its share price is up more than 20 percent; UNG, by contrast, is down more than 35 percent.
That sounds great, but remember, what goes up must come down.
While there is no indication iPath will reopen the note for creations, there is similarly no reason to believe that the premium will persist indefinitely. Anyone buying GAZ at these prices is playing a “greater fool” game, hoping that the already insane premium will become even more insane in the future.
As recent history shows, the premium can fall drastically very quickly: From the March 19 high of 134 percent, the premium fell to 101 percent on March 20, 85 percent on March 23 and 58 percent on March 26. Investors in the fund got crushed, losing 38 percent of their money in a week, almost entirely due to the collapsing premium.
Our recommendation? Sell now.
Of course, the premium could go up further. But there’s no question people are playing funny games with GAZ, and you could lose a lot of money in a hurry.
At some point, this thing is going to fall back to Earth.