DULLES, Va.–(BUSINESS WIRE)–As the Commodities Futures Trading Commission (CFTC) examines the possibility of imposing speculative position limits on “all commodities of finite supply,” the $4.4 billion United States Natural Gas Fund (UNG) moved to reduce its holdings of natural gas futures contracts and indicated that it may not continue to pursue its plans to expand its fund, Natural Gas Intelligence (NGI) reported.
On Wednesday, just one day after the CFTC began holding hearings, UNG formally announced through an 8-K filing with the Securities and Exchange Commission (SEC) that it will actively seek to reduce its holdings of the IntercontinentalExchange (ICE) Henry Financial LD1 Fixed Price Contract. This also follows on the pronouncement Monday by the CFTC that the LD1 contract indeed performs “a significant price discovery function,” and is therefore subject to CFTC regulatory and reporting requirements.
But perhaps more importantly, the fund also announced that it may no longer be willing to issue any new units, or creation baskets, even if it is approved to do so by the SEC. “Due to the very recent changes introduced by ICE and the CFTC, management cannot determine at this time if, in the event that the registration statement was declared effective immediately, UNG could in fact permit the normal creation process to commence again.” UNG is still awaiting approval from its June request with the SEC to issue up to 1 billion additional units, but even if its application is approved, it noted that it may still choose to issue just a portion of that new allotment, or even none at all.
UNG already began the process of paring down its holdings of ICE swaps on Friday, when the fund sold 26,950 September ICE swap contracts and purchased a $250 million, bilateral total return natural gas swap with a series of investment-grade counterparties.
Expect UNG to continue rolling out of its ICE and Nymex positions in the days ahead. “The Nymex [natural gas] futures contracts and the LD1 contract, the economic equivalent of UNG’s benchmark futures contract, have to date provided the best means for UNG to meet its investment objective of tracking percentage changes in the price of the benchmark futures contract,” the fund noted in the 8-K filing. “However, UNG has been forced to consider other investment alternatives in order to avoid violating these new limits and to avoid regulatory action.”
UNG’s action was revealed on Wednesday as the CFTC moved through its second day of hearings on imposing position limits on commodity futures. Based on the commissioners’ questions and comments it appeared it is not a question of whether there will be position limits, but how extensive they will be and how they will be imposed, for instance on the OTC market. Limits might be more successfully imposed on natural gas contracts with the only major market in the U.S. and Canada than on globally traded commodities such as oil and wheat.
Commissioners closely questioned veteran trader and market commentator John J. Lothian, who said passive traders in the commodities markets such as index funds and exchange-traded funds “have become such large dominant players that they are the fundamentals in the marketplace.” Instead of watching supply-demand factors for the actual commodity, traders are watching for the role of the index funds “because that’s the dominant theme in the marketplace, as opposed to, perhaps, cash-futures convergence. That element of it can get overwhelmed,” he said.
Lothian, who publishes the widely read John Lothian Newsletter, said the tremendous exposure of commodities to the large index fund investments “has changed the behavioral aspects of some of those commodities because such a large dominant player is not acting by the rules of the market that I grew up with.” When the market goes up the traditional behavior is for traders to sell and take a profit. With index investors the reaction is to invest more money.
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