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The Natural Gas Market Isn’t Heating Up

Natural gas prices remain low. The storage buildup was 49 Bcf – higher than normal for the season. Extraction season should start in the coming weeks. The rise in production efficiency more than offsets the drop in rigs. Even though the natural gas market is getting closer towards moving from injection to extraction season, the price of natural gas remains low. This upcoming winter is still expected to be warmer than normal. And the rise in efficiency in producing natural gas more than offsets the decline in operating rigs. This trend will keep production higher than last year, which could keep pressuring down the price of natural gas. The recent EIA storage report showed another buildup of 49 Bcf; it wasn’t far off market estimates but was still higher than normal. When it comes to the futures markets, a lot has also changed there, as you can see in the following chart of the differences among prices of near term (next month) and future months. (click to enlarge) Source: EIA Right before the end of October, the contango in the futures markets picked up – an indication for a rise in expected future price of natural gas in the coming months. Since then, however, the contango has contracted and the prices have converged to a narrow spread. This could suggest the market doesn’t anticipate the price of natural gas to sharply rise anytime soon. For holders of the United States Natural Gas ETF (NYSEARCA: UNG ), this could result in a more modest adverse impact from the contango on its pricing with respect to the spot price due to lower roll decay. Looking forward, the market still projects the EIA will report additional buildup in storage next week albeit at a much slower pace; the storage depletion will be reported the following week – at a lower rate than the 5-year average. The EIA, in its recent monthly outlook , expects the U.S. storage will drop to 1,862 Bcf by the end of March – the end of depletion season; this will reflect a modestly lower than average withdrawal from storage due to warmer than normal winter. The EIA projects the overall demand for natural gas will only slightly rise in 2016 compared to 2015 – most of this gain will come in the industrial sector that will offset the decline in power and residential/commercial sectors. But if natural gas prices were to remain this low for a while longer, this may push even further up the demand for natural gas in the power sector, which already is expected to experience a sharp gain in consumption in 2015 of nearly 17%, year on year. These projections don’t vote well for natural gas producers, which have already suffered this year from low oil prices. In terms of rigs, according to the latest update from Baker Hughes , the natural gas rotary rig count fell again by 6 rigs to 193 – nearly 45% lower than the levels recorded last year. Although production has recently declined – as of last week, U.S. natural gas production slipped by 0.5% week over week and is only up by 0.8% for the year – the EIA still estimates production will be up by 6.3% for the year and 2% next year. The higher efficiency of gas producers will more than offset the drop in rig activity. But if prices were to remain this low, this may eventually lead to a slower growth in output as producers scale back on projects and cut capital spending. The natural gas market is likely to remain soft in the near term even as it turns into the extraction season. Unless the winter outlook changes or the number of operating rigs start to tumble down again, prices aren’t expected to rise much higher than their current levels in the near term. For more see: Natural Gas is Still Floating… Barely

Vanguard Extend Duration Treasury ETF: Long Duration Could Be Great In December

Summary The Vanguard Extend Duration Treasury ETF gives investors exposure to the very long end of the yield curve. The yield is material but the price swings on long duration treasuries easily dominate the yield in determining annual returns. I won’t be surprised if the Fed hikes short term rates in December, but I don’t think they can continue to push up short term rates after that. If investors buy into the Federal Reserve’s picture, there could be some great sales on long duration treasuries. The Vanguard Extend Duration Treasury ETF (NYSEARCA: EDV ) is a solid option for exposure to treasuries. The ETF has an expense ratio of only .12%. As I’ve been searching for appealing bond funds, I’ve found some of my favorites are from Vanguard. Given my distaste for high expense ratios, it should be no surprise that the Vanguard products would be appealing. After looking through the portfolio, I think the holdings are fairly reasonable for an investor wanting to regularly keep part of their portfolio in a bond fund. Quick Introduction The Vanguard Extend Duration Treasury ETF is showing a yield to maturity of 3.0% and an average effective duration of 24.6 years. This isn’t an investment that investors should take lightly when it comes to interest rate risk. In my opinion the big reason to use such long duration securities is to reduce total portfolio volatility due to the negative correlation with the market or to make a play on long term yields falling and creating substantial capital gains. Maturities I grabbed another chart to show the effective maturity on the securities: That shouldn’t be surprising given that the effective duration of the fund was running almost 25 years. December The reason I’m looking to keep an eye on the very long duration securities in December is because of the Federal Reserve’s constant pressure to try to increase rates. If they actually get the short term rates higher there may be a shift up across the entire yield curve. The greatest price volatility would come from the long duration bonds. To avoid sensitivity to credit risk, I may opt to use treasuries rather than corporate securities. The Rate Issue The Federal Reserve has been talking for years about raising rates and they finally got some ammunition in November when the “jobs report” came out and indicated that unemployment levels were lower than expected and lower than the previous measurement. The Federal Reserve has an opening and they could use this opportunity to push interest rates higher. I think there is a fairly significant chance of that happening. The latest probability numbers from the CME Group, which uses the “Fed Funds Futures” to track implied probability, is shown below: (click to enlarge) We’re expecting around a 70% chance of short term rates getting a slight boost. I don’t believe that the Federal Reserve can continue to raise rates in the manner that they would like to, but I do think that an increase in short term rates finally happening could create a serious hit in the value of long term treasuries as investors start to buy into the idea that the United States will be creating higher interest rates on treasuries while most of the developed world is showing significantly lower rates. I wouldn’t be surprised if the Federal Reserve raises rates in December and sends bond prices falling. If that happens, I would consider it more likely that they would be forced to go back down on rates in 2016 rather than being able to raise them again later in the year. If short term rates went back down, I think it would be an admission of the difficulties of raising rates in this environment and the 30 year yields would fall. A falling 30 year yield would push prices on EDV materially higher. Conclusion This is a great treasury ETF with a low expense ratio and it should be on the “watch list” for investors going into December. If the Federal Reserve manages to raise rates and the 30 year yields rise (prices fall) materially, then I think it will become a fairly attractive option. I’ll be looking at long duration treasuries in December as a possible way to reduce my portfolio volatility and capture some significant gains if rates fall back down. Over the last year, EDV has had a negative correlation with the S&P 500. This wasn’t a slightly negative correlation either, this was -.41. This serves as potentially a useful hedge against my equity positions while giving me the potential to benefit from falling yields and rising prices if the Federal Reserve is unable to follow through on their plans to raise rates. My view on price movements is a significant chance of prices going lower into December followed by attractive buying opportunities to create capital gains in 2016.

VTHRX: A Great Mutual Fund For The Investor Nearing Retirement

Summary The Vanguard Target Retirement 2030 Fund has a simple construction and a low expense ratio. Despite being a very simple portfolio, they have covered exposure to most of the important asset classes to reach the efficient frontier. This is quite simply one of the best constructed portfolios I’ve seen for a worker nearing retirement. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Vanguard Target Retirement 2030 Fund Inv (MUTF: VTHRX ). What do funds like VTHRX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of VTHRX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of VTHRX. Expense Ratio The expense ratio of Vanguard Target Retirement 2030 Fund is .17%. That is higher than some of the underlying funds, but overall this is a very reasonable expense ratio for a fund that is creating an exceptionally efficient portfolio for investors and rebalancing it over time to reflect a reduced risk tolerance as investors get closer to retirement. In short, this is a very solid value for investors that don’t want to be constantly actively management their portfolio. This is the kind of portfolio I would want my wife to use if I died prematurely. That is a ringing endorsement of Vanguard’s high quality target date funds. Composition The fund is running almost 75% stocks to about 25% bonds, but over time the portfolio shifts to sell off stocks and hold more bonds as Vanguard assumes that investors nearing retirement will have a reduced risk tolerance. This portfolio strategy is the embodiment of what financial advisors seek to do for clients. Unfortunately Vanguard does not know the unique circumstances of every client, but for a .17% expense ratio they are doing a great job. Holdings / Composition The following chart demonstrates the holdings of the Vanguard Target Retirement 2030 Fund: (click to enlarge) This is a fairly simple portfolio. Only four total funds are included so the fund can gradually be shifted to more conservative allocations by making small decreases in equity weightings and increases in bond weightings. The Vanguard Total Stock Market Index Fund is the largest holding at 45% of the portfolio and it is also available as an ETF. The ETF version is the Vanguard Total Stock Market ETF (NYSEARCA: VTI ). To be fair, Vanguard has a great reputation for running funds but not for coming up with creative names. I have a significant position in VTI because it carries an extremely low expense ratio and offers excellent diversification across the U.S. economy. Volatility An investor may choose to use VTHRX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. Since the fund includes domestic and international exposure to both equity and bonds, that seems like a fair way to analyze it. (click to enlarge) When we look at the volatility on VTHRX, it is dramatically lower than the volatility on SPY. That shouldn’t be surprising since the portfolio has some very material bond positions. Investors should expect this fund to retain dramatically more value in a bear market and to fall behind in a prolonged bull market. Investors may recognize that the max drawdown for this fund was not that much weaker than the max drawdown for the market overall. That is strongly related to this portfolio being designed for people that will retire in about 15 years from now or 23 years from the crash of 2007. It would be unwise for Vanguard to become too conservative. While the fund has underperformed the S&P 500 by a notable margin, it is worth noting that part of that underperformance has been tied to international markets doing quite poorly relative to the S&P 500 over the last several years. Over the longer horizon I think it would be absurd to expect the domestic markets to continue beating the international markets so thoroughly. When it comes down to it, VTHRX is doing a very solid job of providing risk adjusted returns for the passive investor. Conclusion VTHRX is a great mutual fund for investors looking for a simple “set it and forget it” option for their employer sponsored retirement accounts. It is ideally designed for investors planning to retire around 2030, but can also be used by younger employees with lower risk tolerances or older workers with higher risk tolerances.