AIM Pitch Profiting from GAZs Premium to NAV

Adam Wiklund April 11, 2012

Agenda
1.

Recommendation

2.
3. 4. 5. 6.

How did we end up in this situation?

Why will the stock price converge back to its NAV? How do we profit from this?

Risks
Conclusion

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Recommendation
The situation
GAZ has traded at a large premium over its NAV this year as a result of increased interest in natural gas combined with the ETNs small market cap and its issuer temporarily suspending new issuance

What is GAZ?
An ETN designed to provide exposure to natural gas as measured by the DJ-UBS Natural Gas Subindex Total Return ETNs are senior, unsubordinated, unsecured debt securities Issued by Barclays Bank PLC

The trade
Sell short GAZ Buy UNG (a different natural gas ETF)

Why it will work

At least 3 catalysts will make this trade profitable Compelling history

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GAZ vs. UNG

GAZ Product structure Investment objective Listed exchange ETN
Track DJ-UBS Natural Gas Subindex Total Return

UNG ETF
Track the spot price of natural gas delivered to Cushing, OK

NYSE (ARCA)

NYSE (ARCA)

Last price Avg. 3 month volume

Premium/discount Management fee

$3.57 790,000
4/9/12 = 82% 4/5/12 = 103% 0.75%

$15.24 8,700,000
-0.3% 0.60% $751 million

Market cap (as of 4/6/12) $64 million

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How did we end up in the current situation?

DJ-UBS & S&P GSCI rebalancing at the beginning of the year resulted in increased volatility and market activity

Source(s): ETF Securities, Bloomberg

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Obamas State of the Union address resulted in increased interest in natural gas (both on the long and the short side)

January 24, 2012

Praised the United States abundant natural gas reserves

Announced his administration will open more than 75% of the countrys potential offshore oil and gas resources Made commitments to increase natural gas drilling and renewable energy Hydraulic fracking industry has potential to create more than 600,000 jobs over the next 10 years

Source(s): Allianz Investors and Bloomberg

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Open interest in natural gas futures has spiked in 2012 for both commercial and non-commercial longs and shorts

Source(s): CFTC
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Short interest (gold lines) and volume (blue bars) pick up in 2012 for both GAZ (top chart) and UNG (bottom chart)

Source(s): S&P Capital IQ

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but only GAZ trades at a large premium

This is partly due to
Barclays suspending issuance of new shares

GAZs small market cap

Source(s): Bloomberg
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Prior to August 21, 2009, Barclays issued and redeemed shares of GAZ to keep the ETN in line with its NAV

Source(s): Bloomberg
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On August 21, 2009, Barclays announced it has temporarily suspended any further issuances. Redemptions were not affected.

Source(s): Bloomberg
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UNGs market cap is 13 times larger than GAZs so its stock price is not as easily distorted

Source(s): S&P Capital IQ

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Increased interest and volatility in natural gas, combined with a low market cap and a lack of new share issuances, has resulted in a large premium

State of the Union Address

Source(s): Bloomberg
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Why will the stock price converge back to its NAV?

Three catalysts that will cause the stock to trade closer to its NAV

Catalyst #1: Barclays ends its temporary suspension of new issuances

Least likely but most desired outcome
TVIX/UNG examples

Catalyst #2: Investor education

Somewhat likely outcome The amount of time for this to play out is very uncertain Lacks tangible event

Catalyst #3: Short sellers depress the stock price

Most likely outcome Compelling historical results

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Previous spikes in the premium were relatively short-lived as a result of short sellers entering the market in large enough numbers to normalize the stock

Source(s): Bloomberg
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How do we profit from this?

GAZ and UNG have a very high correlation when traded at their NAV, and a pairs trade can be created to strip out natural gas exposure.

Source(s): Bloomberg
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Several choices are available to take advantage of the dislocation in the market
Choice #1: Short GAZ and go long UNG
My top choice due to simplicity and time flexibility, but costs/availability may restrict this choice
Trade: Short 328 shares of GAZ at $15.24 ($4999) Buy 1400 shares of UNG at $3.57 ($4998)

Choice #2: Short GAZ synthetically using options and go long the UNG ETF
A good alternative, but option premiums eat into the profits and the time horizon is limited by the options expiration date Trade: Short 4 calls with $4 strike and 9/22/12 expiration at $0.40 each (-$560) Buy 4 puts with $4 strike and 9/22/12 expiration at $1.70 each ($2,380) synthetic short at $2.70

Buy 248 shares of UNG at $15.24 ($3,780)

Choice #3: Sell calls in GAZ at its NAV to buy calls in UNG
Difference in expiration Trade: Short 25 calls with $2 strike and 9/22/12 expiration at $1.55 each (-$3,875) Buy 3 calls with $16 strike and 10/20/12 expiration at $1.93 each ($579)

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Key risks to consider and conclusion

Key risks
Barclays credit risk
Negligible

Small market cap

Less than $100 million

Premium may continue to rise

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Conclusion
The situation
GAZ has traded at a large premium over its NAV this year as a result of increased interest in natural gas combined with the ETNs small market cap and its issuer temporarily suspending new issuance

What is GAZ?
An ETN designed to provide exposure to natural gas as measured by the DJ-UBS Natural Gas Subindex Total Return ETNs are senior, unsubordinated, unsecured debt securities Issued by Barclays Bank PLC

The trade
Sell short GAZ Buy UNG (a different natural gas ETF)

Why it will work

At least 3 catalysts will make this trade profitable Compelling history

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Appendix

Source(s): Bloomberg
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Source(s): Bloomberg
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Source(s): Bloomberg
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Source(s): Bloomberg
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