July 8 (Bloomberg) -- The United States Natural Gas Fund expanded today to the largest position in its 27-month history as investors snapped up the last of its shares and it awaited government approval to issue more units.

As of early today, the exchange-traded fund owned the equivalent of 124,926 natural gas futures contracts on the New York Mercantile Exchange. The number of shares outstanding reached a record yesterday, rising 14.5 percent to 322.3 million, more than 10 times the total at the start of the year, and worth $3.97 billion.

The fund’s natural gas position, spread across swaps and futures on the Nymex and the ICE over-the counter-market, equals the equivalent of 86 percent of the open interest in natural gas futures on the NYMEX.

“Clearly, this has become an extraordinarily attractive investment,” said Dave Nadig, an associate editor at IndexUniverse.com, in Decatur, Georgia. “There’s a lot of speculation among people like us who are wondering who is in this.”

The ETF can’t grow further for now because yesterday it ran out of new shares to issue. The ETF asked the Securities Exchange Commission on June 5 for permission to create 1 billion new shares, and is awaiting approval.

John Heine, spokesman for the SEC, said yesterday the timeline for approval varies from case to case.

The fund rose 2 cents, or 0.2 percent, to $12.20 on the New York Stock Exchange. It’s down 47 percent this year, while natural gas has fallen 40 percent on the Nymex.

“The size of their position is so big that it creates distortions in the market,” said Olivier Jakob, managing director of PetroMatrix in Switzerland. “And that doesn’t mean it just drives prices up. It can also drive prices down.”

Fund Holdings

The ETF publishes its holdings every day. The fund holds the near-month contract and rolls it into the second month as the near month approaches expiration. The timing of its four-day roll is listed on the company’s Web site.

As the fund reaches the roll period, it has to sell its position in the near month contract, depressing the near-month price, Jakob said. It also has to buy a commensurate position in the second month, pushing that price up, and widening the contango. Jakob said that natural gas prices will only begin to rise when the fund shrinks its position.

Nadig said that while the size of the fund may contribute to volatility, it doesn’t have a significant impact on price.

“It’s easy to play the what-if game,” he said. “What would the market look like if we didn’t have this multibillion fund in the market?”

Outstanding Shares

The natural gas fund has an open-ended number of shares. It creates new shares or redeems outstanding shares in baskets of 100,000. The money is invested in near-month natural gas futures, rolling the contracts forward to the second month as the near month approaches expiration.

Without the ability to issue new shares, the fund may begin trading like a closed-end fund with significant premiums from the value of its underlying assets, according to a report today from Jefferies Equity Strategy.

The Alameda, California, fund is one of a family of funds owned by the United States Commodity Funds LLC. The company has funds invested in crude, gasoline, and heating oil. It recently asked the SEC for permission to register shares for a fund that would short oil.

“ETFs really have opened up the door to retail investors, traders and institutional investors to more easily invest in commodities,” said Tom Lydon, president and chief executive officer of Global Trends Investments and editor of ETF Trends.

Lydon, whose firm has $80 million under management, said market conditions will continue to attract investors to commodities.

ETFs provide an efficient, low-cost, liquid alternative for investors that don’t want to get directly into the futures market, he said. Lydon predicted that commodity funds will continue to grow. The billions of dollars that has flowed into the natural gas fund and other commodity ETFs is just the “third or fourth inning.”

To contact the reporter on this story: Asjylyn Loder in New York aloder@bloomberg.net.

Last Updated: July 8, 2009 17:08 EDT