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UWTI And UGAZ: A Cautionary Tale Of Fortunes Won And Lost

Summary 3X commodity ETNs are overwhelmingly volatile and risky. UWTI and UGAZ are widely traded ETNs that should be approached with a sober and patient mind. 3X commodity ETNs have potential for huge gains as well as catastrophic losses. Introduction This summer, I took on the arduous task of learning the ins and outs of leveraged commodity ETNs. Like many foolish investors before me, I firmly believed I could trade these volatile monsters and actually make serious money. I began with a meticulous research in an attempt to determine a central price point in which to buy and sell. I learned about the holdings of each ETN, and I learned how these funds were leveraged to attain daily 3X returns. I transferred a percentage of my funds to a commission-free brokerage account (Robinhood). Then, drunk on overconfidence in my own ability to predict future market behavior, I set out to make my fortune. ETN Functionality After extensive research, I came to the conclusion I could profit most off of the volatility of natural gas and crude oil futures. My weapons of choice included VelocityShares 3X Inverse Crude Oil ETN (NYSEARCA: DWTI ), VelocityShares 3X Long Crude Oil ETN (NYSEARCA: UWTI ), VelocityShares 3X Inverse Natural Gas ETN (NYSEARCA: DGAZ ), and VelocityShares 3X Long Natural Gas ETN (NYSEARCA: UGAZ ). I wanted to utilize the maximum amount of leverage to capitalize heavily on price swings. I learned everything I could about the benefits of 1X, 2X, and 3X leverage. I’ll include them here , but if you’re reading this article, you likely already understand the risks and rewards. I’ll briefly mention the underlying financials, but chances are you understand those too. Each ETN is issued by Credit Suisse and traded on the NYSE. All four indexes I mentioned have market capitalizations over 100 million and are traded very heavily over millions of times each day. They are designed to track daily performance, and they are not designed to be held for extended periods of time. ETNs have a veritable laundry list of risks , and they suffer from significant contango over time. Additionally, these ETNs have an expense cost and no dividends. The point is that they are essentially designed to lose money in the long run. Don’t believe me? Look at the long-term returns of each. With the exception of DWTI (for obvious reasons), ETNs perform sub optimally in the long term. They should be used for short-term performance only. Determining Price: Market Conditions I approached pricing from (what I believed to be) a logical top-down view. In regards to oil , I felt it had been oversold, because China’s economy was not slowing as much as believed, Iran had already been priced in, the Greek crisis was overblown, and rig increases were a sign of strength (not weakness). I also looked at world supply and demand, OPEC projections, and EIA estimates. I came to the conclusion that a fair short-term price for crude (WTI) was $57, though a selloff could push oil to $53. Never did I think prices would go as low as $51. For natural gas , I looked at EIA.gov forecasts, and I looked at world supply and demand. Natural gas consumption seemed (and seems) poised to gradually increase over time. The recent influx of natural gas, particularly from the shale boom and improved technology (fracking, etc.) had been decimated by cheap energy over the past year. I concluded that natural gas supply would gradually rebound as well to match rising consumption. I also came to the conclusion that the wide held notion that El Nino would cause a “cool summer” was misunderstood and false. With those underlying assumptions, I moved on to figuring out a fair price to gauge when I should buy and sell the ETN. Determining Price: Central Swing Point 3X ETNs are inherently volatile. I included UGAZ to visually provide an example of daily price swings. These securities also reset each day and often can start significantly higher or lower than they ended from the day before. They generally swing up and down around a central point and rally significantly in trending markets. ETNs also decay over time, so it is advisable to trade daily rather than over a long term. For each ETN, I created a monthly average point for each index and compared them to their underlying future prices. I created my own “fair price point”, and whenever the price dipped around 5%-10% of my preconceived fair price, I would snatch up equity. For example, my fair price for UGAZ (as I mentioned about a month ago) was 2.1. Whenever UGAZ fell to a price around 2.00, I generally would proceed to purchase the stock and wait for it to rebound above 2.1. I sold UGAZ whenever it hit 2.20. My “fair price points” for the others were $3.2 for UWTI, $62 for DWTI, and $5.55 for DGAZ. Equipped with my “fool proof” strategy, I went forth to make some money. Building a Fortune – What Went Right My first (and arguably smartest) course of action was to put my money into a zero-commission account before making a large number of trades. ETN trading is day trading, and I did not want some broker to siphon off my earnings. From June 12-June 29, I made almost 30%. For my first trade, I bought UGAZ around 2.1 (I didn’t let it fall the first time) on June 12 and sold at 2.32 on June 14. Then, I purchased DGAZ at 5.31 on June 15 and sold at 5.45 on June 17. I was already off to a decent start. Next, I moved to UWTI; I bought on June 19 at 3.37 and sold at 3.55 on the 23rd of June. I believed I was infallible. I proceeded to buy DWTI on June 23 at 61 and sold on June 29 at 69. I felt on top of the world, and ultimately my swelling pride became my downfall. Losing Everything – Where I Went Wrong On July 1st, I went all in on UWTI at 2.88, thinking I had gotten a steal. On July 6th, I sold my position at 2.12 thinking oil prices would keep dropping based on negative sentiment. I over exposed myself, and I lost the majority of my gains. I didn’t follow my own beliefs about crude (that the selloff was irrational), and I realized a loss that I shouldn’t have. I could have easily held UWTI for another couple days and sold at 2.25 even. Instead, I got cocky and then I got scared. I also lost sight of the most important fact of futures trading. No one can truly predict where prices are going to go. Energy is volatile, and speculation is rampant. 3X ETNs can easily drop off in one day. The thrill of 10% gains in a single day had gotten the best of me. Conclusion I made my last trade on July 9. I bought UGAZ at 1.90 and sold it on Monday at 2.20. With that trade, my overall returns were slightly above even, and I consoled myself with the idea that I would turn my back on futures once and for all. Now, I research long-term value stocks, but every once in a while, the thrill of trading crosses my mind. These stocks are definitely not for the faint of heart or risk averse. For those bold traders who want to make a fortune in a single day, just remember that you can lose it all at any moment. Investing in 3X ETNs is legalized gambling, and UWTI, DWTI, UGAZ, and DGAZ ought to only be considered in very specific situations (such as hedging). Heed my warning and proceed with caution when considering these three 3X ETNs. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

UGAZ Heats Up With The Summertime

Summary Its optimal pricing is based around the 52-week low. Record heat projections will drive consumption. Improved technology and increasing demand will bolster exports. Basic Information This index is composed entirely of natural gas futures contracts and is derived by reference to the price levels of the futures contracts on a single commodity as well as the discount or premium obtained by rolling hypothetical positions in such contracts forward as they approach delivery. Currently, Velocity Shares 3X Long Natural Gas ETN (NYSEARCA: UGAZ ) is priced at 2.29. UGAZ was created 02/07/12. There are 295.6 Million shared outstanding, no dividends, and a high expense ratio at 1.65. It is a very volatile ETN and should not be traded without serious forethought. I recommend buying UGAZ around a target price of 2.1 throughout the duration of the summer. Also, its competitors include: BOIL , UNG , DGAZ , and DWTI . Investment Summary Case for Buying: Record summer heat projections exacerbated by warm Pacific upwelling from El Nino will increase consumption. The Energy Information Administration projects increasing consumption and demand from 2015-2016 particularly in the short term. Increasing export demand from Mexico and domestic cost cutting will improve profitability. Decreased rig count and decreased crude oil production may lead to higher crude prices. Increasingly efficient and improved drilling techniques and increased exploitation of the Marcellus Shale will lead to domestic production particularly in the Gulf of Mexico may increase natural gas demand due to the historically inverse relationship between natural gas and crude oil. Increasing coal retirement due to more stringent regulation may lead to higher demand for cheaper energy sources such as natural gas. This is a possible value buy around 52 week low. Case for Abstaining: Natural gas historically has shown massive volatility and comes with high risks. UGAZ in particular has a very high expense ratio. Seasonality and increasing natural gas consumption from A/C and other sources may already be accounted for in the price of the ETN. Rise in prices may cut affect profitability margins. Record Summer Heat El Nino is here and world temperatures are expected to be hotter than average this summer. Particularly Southern Upwelling near South America will lead to hotter conditions in South/Central America as well as the majority of the west coast. Temperatures will be hotter than average along parts of the East coast as well. The center of the US, however, will be slightly cooler than average. Overall hotter temperatures will increase natural gas prices as consumption increases particularly from A/C and industrial consumption. Natural Gas Consumption The Energy Information Administration forecasts total natural gas consumption at 76.6 Bcf/d (billion cubic feet per day) in 2016, 76.7 bcf/d in 2015 on average (which accounts for the warmer than average winter). Consumptive growth has largely been driven by industrial and electric power sectors. Seasonal usage generally peaks in mid July. Natural Gas Replacing Coal? Increasing worldwide pressure to limit carbon emissions and implement emission caps may be detrimental to the coal industry. Cleaner burning natural gas may prove to be a viable alternative. The coal industry is transitioning towards clean coal technology, however the R&D and process of implementing the technology will be a long and expensive process. Natural Gas Production and Trade Natural gas production is expected to increase by 4.2 bcf/d (5.7%) and 1.6 bcf/d from 2015 to 2016 alone. Increasing production in lower 48 states is expected to offset declining production in the Gulf of Mexico. Increase drilling efficiency will continue to support growing natural gas production despite relatively low natural gas prices. Most growth is expected to come from the Marcellus Shale. Many backlogged wells are expected to be completed and new pipelines are expected to deliver Marcellus gas to the Northeast. Increased domestic production is expected to reduce demand for Canadian imports and increase export demand to Mexico. Exports from the Eagle Ford Shale are expected to supply growing demand from Mexico’s electric power sector, coupled with flat Mexican natural gas production. LNG gross exports expected to increase to 0.79 bcf/d in 2016 with increasing build of major LNG liquefaction plant in lower 48. Natural Gas Prices The average commodity price was 2.85/MMBtu in May (24 cent increase from April). It is projected at: $2.97 in 2015 and $3.32 in 2016. The government projects steadily increasing prices, demand, and consumption of natural gas in the near future. Also, seasonality investor sentiment, and volatility from 3X leverage may help UGAZ push higher. UGAZ Trend UGAZ data by YCharts UGAZ is near its 52 week low which may indicate it is undervalued; however, it is not traded like a regular equity. Due to the nature of 3X levered ETN’s it is subject to contango (decay) and other variables included in the disclosure. In the short term UGAZ is poised to swing higher, though it would be prudent to wait for it to decrease to a $2.1 price range. Risks/Bearish Case I included a disclaimer for the risks of leveraged ETFs below; however, other points to consider include: 1. Natural gas price increases may only be marginal in the short term 2. UGAZ has a very high expense ratio that is justified by its volatility 3. UGAZ is high risk/high reward in nature and should not be invested in without serious forethought. Anything less is gambling 4. There are safer alternatives. UNG tracks U.S. natural gas one to one and I believe is a safer investment Disclaimer: The risks of investing in a 3X leveraged commodity trading vehicle like UGAZ/UWTI are much greater than those of other vehicles. These risks include (source: Velocitysharesetns.com/ugaz ): 1. ETNs are only suitable for knowledgeable investors seeking daily exposure (including inverse or leveraged exposure) to the underlying index. ETNs are intended for short-term trading, therefore investors with a horizon longer than one day trading should carefully consider whether the ETNs are appropriate for their investment portfolio. 2. Because the inverse leveraged ETNs and leveraged long ETNs are linked to the daily performance of the applicable underlying Index and include either inverse and/or leveraged exposure, changes in the market price of the underlying futures will have a greater likelihood of causing such ETNs to be worth zero than if such ETNs were not linked to the inverse or leveraged return of the applicable underlying Index. 3. The ETNs do not guarantee any return of principal at maturity and do not pay any interest during their term. 4. At higher levels of volatility, and since the ETNs are not principal protected, there is a significant chance of a complete loss of ETN value even if the performance of the index is flat. 5. The closing indicative value on each valuation date is determined in part by reference to the daily percentage change in the level of the underlying index. As a result, to the extent the closing indicative value of the ETNs is greater than or less than the initial indicative value, subsequent changes in the level of the index may have a bigger or smaller impact on the closing indicative value of the ETNs than if the closing indicative value remained constant at the initial indicative value. For example, assuming an initial indicative value of $100, if the closing indicative value of the ETNs increases above $100, a subsequent 1% daily change in the level of the index will result in more than a $1 decrease in the closing indicative value of the ETNs. Likewise, if the closing indicative value of the ETNs is less than $100, a 1% increase in the level of the index will result in less than a $1 increase in the closing indicative value of the ETNs. 6. If the level of the underlying index decreases or does not increase sufficiently (or if it increases or does not decrease sufficiently in the case of the inverse ETNs), to offset the effect of the Daily Investor Fee over the term of the ETNs, the investor will receive less than the principal amount of his investment upon early redemption, acceleration or maturity of the Notes. 7. This particular ETN also runs the risk of being decayed by contango which is defined by Investopedia as: 8. A situation where the future price of a commodity is above the expected future spot price. Contango refers to a situation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity. This may be due to people’s desire to pay a premium to have the commodity in the future rather than paying the costs of storage and carry costs of buying the commodity today. 9. Finally, there are general risks that should also be considered such as liquidity risk (Source: Investopedia.com): 10. The risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. Liquidity risk is typically reflected in unusually wide bid-ask spreads or large price movements (especially to the downside – which are magnified in leveraged ETNs). The rule of thumb is that the smaller the size of the security or its issuer, the larger the liquidity risk. Comparisons – Three-Year Graphs In relation to TNX (10X 10-year yield) : In regards to my goal of finding an adequate hedge to 10 year interest rates, I chose to compare TNX to UGAZ. In many regards, UGAZ has shown to move inversely to TNX, albeit in a dramatic and imperfectly correlated fashion. I believe higher interest rates stifle exploration, extraction, and innovation in the energy sector which lead to higher costs and explain the inverse relationship between the two indexes. However, there are so many other factors that affect each index that it is extremely difficult to make such broad speculations. For example, Natural gas is subject to all the risks that come with commodities. Demand, seasonality, consumption, pricing, weather, regulation, etc. Interest rates are subject to different forces altogether. For example, monetary policy, the federal reserve, inflation, etc. UGAZ is a good hedge in the sense that one can hedge risk vs. riskless investments. As investments go, UGAZ is about as risky as they come, while investing in an etf tied to treasury yields has far less risk or indexes reflecting the treasury yield is about as riskless as an investment as one can make. UGAZ is good for managing risk. Playing UGAZ in the long term (more than a year) would be unwise because of its volatile nature. Relation to UNG (red line) UNG is the regular natural gas ETF while UGAZ is a tripled levered ETN. An investor looking to play natural gas long would be far better off investing in UNG in order to manage market risk and decrease market fees. UNG is a less risky investment and a better play in the long term. For short term trading, though UGAZ is a far more exciting play. Relation to UWTI (red line) UWTI is the 3X levered Crude oil index. Like UGAZ, its price is derived from crude oil futures, and it is not to be traded lightly. UGAZ has been more volatile in recent years. Interestingly, UGAZ and UWTI have historically been inversely correlated to one another. However, in the last the year the flooded energy market has caused both crude and natural gas to take a correlated nose dive in price. Crude is expected to stabilize around $60 for the next couple years until increasing in price as consumption and demand rise to meet supply. Conclusion I believe there is a very good chance natural gas prices and consumption will continue to increase over the summer. A hot summer, increasing demand, battered prices, decreasing usage of coal, and improvements in technology all contribute to this view. UNG would be an optimal investment in natural gas; however, UGAZ would be a better short term tool for managing risk and could potentially pay out huge rewards (though with high risks and potential for decay). Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

UGAZ Capitulates On ‘The Bloodbath’ – It’s Time To Get Long

Summary UGAZ, as expected, capitulated into “The Bloodbath” that was inventory on another miss. UGAZ held $2.50 strong and I believe is a nice round number that energy desks will build positions around. BUY UGAZ or DCA into a lower cost basis if you’re already long – “The Turn” has happened. With the EIA Natural Gas Inventory report coming in at -115 BCF against expectations of -121 BCF and the subsequent drop in natural gas pricing, which is most popularly played using The United States Natural Gas ETF, LP (NYSEARCA: UNG ), I believe post- Blood Bath the bottom for natural gas is in. I’ll explain further. (click to enlarge) After outlining the longer term natural gas bull thesis (click “Blood Bath” above) I believe “The Turn” for natural gas pricing has happened. Now, what does that mean? I can’t possibly outline my positions in real time to readers outside of guiding that I own VelocityShares 3x Long Natural Gas ETN (NYSEARCA: UGAZ ) at $2.90 and will add to my position tomorrow in the early AM to average down my cost basis. Over the next 9 months I’ll be offloading and adding to my net natural gas exposure, inclusive of selling and buying UGAZ and inclusive of selling and buying hedges via UNG options, in an effort to maximize the longer term bullish trend. I’ve ridden trends using this strategy the last two years with great success both on the long and short side. (click to enlarge) So, I’ll outline my thoughts on immediate term, mid-term, and longer term trends with following recommendations – this will become a regular section of these weekly updates, make sure to # FOLLOW me and subscribe to real time alerts for the UGAZ ticker: Immediate Term (next 7 days): bullish, BUY. This is going to be against consensus as weather is expected to be in the mid-70’s for HOD’s for the middle part of the country with LOD’s coming in at just over 50 degrees. Normally, this would be bearish and it just might be during the next 7 days leading into inventory. IF UGAZ is hit – BUY (see Long Term bullet) as we are at what should be generational lows. I’m going against consensus in estimating that UGAZ is higher than its most recent close of $2.48 but 1) I just can’t imagine cooling demand not upticking in the middle part of the country (namely Texas) as this will be the first time in a long time that folks have felt anything resembling heat, I’m betting folks overreact in that it will “feel” hotter than it is and that cooling demand comes on strong and 2) I can’t imagine big energy desks not beginning to build longer term positions right here, that should provide some volume on any drops to pricing. Mid Term (next 30 days): Mixed to flat as of right now, BUY in the immediate term and wait on further buys. Guys, I had watch the inventory report post greater than 90 BCF reports 8 consecutive weeks in the middle of summer (including builds of 91BCF, 87BCF, 94BCF, 105BCF, 112BCF, 97BCF, 90BCF, 92BCF), the middle of what was supposed to be the bull thesis, before the market gave me some credit and ran natural gas pricing down. I was looking VERY foolish for about two months as the price of natural gas was denying all fundamentals. Eventually, everything has to be priced efficiently and thank goodness I had conviction in my short position. That said, I’m never willing to say that my thesis will play out exactly on time or exactly in lock step with developments. Wait on further buys in the mid-term once you get some position on the board at these lows. Long Term (longer than 30 days): bullish, BUY on dips as far as $2.00. I have no question natural gas is higher than its current close in 30 days. If you plan on buying for the long term and not trading around you should build positions on dips down to $2.00. No questions natural gas is at the lows. We’ll see over the next few weeks how many institutional holders have to be wrong (by selling or shorting natural gas) but just like always eventually they’ll come around. If you’re in this name for a once a month buy/sell the decision to buy is easy. Just do it. I understand I can post one update article per regular long article so if a major weather change develops or something else comes along that would change my immediate term opinion I’ll post an update article. Check back daily to make sure no updates have been posted. Remember, mid-term and longer-term reco’s aren’t effected by week to week developments. Also remember, the current bull thesis is as follows: Falling rig counts hurt overall production – that’s good for the supply side of the equation as production is slowed overall. Less oil E&P to come on lower CAPEX across the board for oil and natural gas E&Ps – that’s also good for the supply side of the equation (Source: Bloomberg.com). I’m betting on the fact that spring will start early and summer will be, well, it’ll be hot – that’s good for the demand side of the equation – for clarity these projections are based on longer term weather models from Weather.com which may be unreliable. I believe at poor hedging or at lower than ideal aggregate hedging that natural gas E&P names won’t “pump baby pump” as hard into what has been excellent hedging in size the last few years – that’s also good for the supply side. Examples of companies I’ve reviewed that have 1) less than ideal pricing hedging or 2) less than ideal aggregate hedging coverage are Chesapeake Energy Corporation (NYSE: CHK ), Antero Resources Corporation (NYSE: AR ), Ultra Petroleum Corp. (NYSE: UPL ), Halcon Resources Corporation (NYSE: HK ), SandRidge Energy, Inc. (NYSE: SD ), Quicksilver Resources Inc. (NYSE: KWK ), etc. This list could have been 50 names deep. Finally, please read the disclosure section of this article as playing leveraged commodity ETN’s is dangerous and requires a constant monitoring of positions. Good luck everybody, I’ll see you next week in The Lounge. Disclosure The risks of investing in a 3X leveraged commodity trading vehicle like UGAZ/DGAZ are much greater than those of other vehicles. These risks include (Source: Velocitysharesetns.com/ugaz): ETNs are only suitable for knowledgeable investors seeking daily exposure (including inverse or leveraged exposure) to the underlying index. ETNs are intended for short-term trading, therefore investors with a horizon longer than one day trading should carefully consider whether the ETNs are appropriate for their investment portfolio. Because the inverse leveraged ETNs and leveraged long ETNs are linked to the daily performance of the applicable underlying Index and include either inverse and/or leveraged exposure, changes in the market price of the underlying futures will have a greater likelihood of causing such ETNs to be worth zero than if such ETNs were not linked to the inverse or leveraged return of the applicable underlying Index. The ETNs do not guarantee any return of principal at maturity and do not pay any interest during their term. At higher levels of volatility, and since the ETNs are not principal protected, there is a significant chance of a complete loss of ETN value even if the performance of the index is flat. The closing indicative value on each valuation date is determined in part by reference to the daily percentage change in the level of the underlying index. As a result, to the extent the closing indicative value of the ETNs is greater than or less than the initial indicative value, subsequent changes in the level of the index may have a bigger or smaller impact on the closing indicative value of the ETNs than if the closing indicative value remained constant at the initial indicative value. For example, assuming an initial indicative value of $100, if the closing indicative value of the ETNs increases above $100, a subsequent 1% daily change in the level of the index will result in more than a $1 decrease in the closing indicative value of the ETNs. Likewise, if the closing indicative value of the ETNs is less than $100, a 1% increase in the level of the index will result in less than a $1 increase in the closing indicative value of the ETNs. If the level of the underlying index decreases or does not increase sufficiently (or if it increases or does not decrease sufficiently in the case of the inverse ETNs), to offset the effect of the Daily Investor Fee over the term of the ETNs, the investor will receive less than the principal amount of his investment upon early redemption, acceleration or maturity of the Notes. This particular ETN also runs the risk of being decayed by contango which is defined by Investopedia as: A situation where the future price of a commodity is above the expected future spot price. Contango refers to a situation where the future spot price is below the current price, and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity. This may be due to people’s desire to pay a premium to have the commodity in the future rather than paying the costs of storage and carry costs of buying the commodity today. Finally, there are general risks that should also be considered such as liquidity risk (Source: Investopedia.com): The risk stemming from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss. Liquidity risk is typically reflected in unusually wide bid-ask spreads or large price movements (especially to the downside – which are magnified in leveraged ETNs) . The rule of thumb is that the smaller the size of the security or its issuer, the larger the liquidity risk. Disclosure: The author is long UGAZ. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Additional disclosure: The author is long UGAZ at equal sizes at $2.90 and $2.48. The author has a cost basis of $2.69