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Should You Bet on Gasoline ETF on Soaring Demand?

The slide in crude oil price early this year came as a boon to car owners and revived the investment case for gasoline and its ETF. This is especially true as U.S. gasoline demand hit a record high of 9.25 million barrels per day in March, reflecting a 2.2% increase year over year and a 1.6% increase from February, as per the American Petroleum Institute. Notably, U.S. is the biggest consumer of gasoline, accounting for about one-third of global demand.

The surge in demand was mainly driven by an unusually warm weather and of course cheap fuel. According to the automobile club, pump prices in the U.S. averaged under $2 a gallon every day this year till March 24, representing the lowest level in 12 years. Further, an accelerating labor market with net additions of more than 200,000 jobs in both February and March as well as higher purchase of sport-utility vehicles and trucks gave a boost to demand (read: ETFs to Gain or Lose After Strong Jobs Report).  

This trend is likely to continue given that Americans will enjoy the cheapest gasoline while driving to their summer destinations, increasing demand by 1.4% year over year. Drivers are expected to pay 59 cents a gallon less at the pump this summer than what they paid last summer and $1.55 less than the summer of 2014, as per the Energy Information Administration (EIA). The agency expects U.S. regular gasoline price to average $2.05 a gallon in April and $2.08 a gallon in June, followed by lower prices in the second half of 2016.

Investors could take advantage of surging gasoline demand by focusing on United States Gasoline ETF (UGA), which allows investors to make a direct play on RBOB gasoline. The fund provides investors with exposure to front-month gasoline futures, tracking RBOB gasoline for delivery to the New York harbor which is traded on NYMEX. The ETF is less liquid with daily trading volume of about 99,000, suggesting that investors have to pay extra beyond the annual fee of 60 bps. The fund has amassed $87.2 million in its asset base so far (read: 5 ETFs to Buy if Oil Stays at $40).

State of Contango: A Major Threat to UGA

As traders need to roll from one futures contract to another to avoid physical delivery, the fund is susceptible to roll yield. Notably, roll yield is positive when the futures market is in backwardation and negative when the futures market is in contango. Basically, if the price of the near month contract is higher than the next month futures contract, then it is backwardation and the case is the opposite for contango.

Currently, the gasoline futures market is in a state of contango, which is bearish for the commodity and the gasoline ETF. The situation is expected to continue all throughout summer, wiping out all the profits garnered from strong seasonal trends. As a result, investing in UGA would be foolish for investors looking for a concentrated play on the gasoline segment of the energy market at present (see: all the Energy ETFs here).  
 
However, the movement might rebound in August as the RBOB gasoline futures contract for August is trading higher than the next month contract (September), signaling a positive roll yield.
 
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US GAS FUND LP (UGA): ETF Research Reports
 
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