Commodity Indexes

If an asset class exists, you can bet that someone has made an index of it. Indexes are great to use as benchmarks, for forecasting and research, and for designing investment vehicles around them. As with other indexes, you can't buy an index, but you can buy an investment designed to mimic one.

The oldest and most used is the S&P GSCI (this name comes from the fact that it used to be called the "Goldman Sachs Commodity Index"). It's the only major index that is purely production weighted, meaning that the effect of crude oil price changes is the biggest, since it's weighted by the production value of each of the 24 commodities in the index. What in the stock world does that weighting remind you of?

Exactly! It's like the benefit of using the S&P 500 Index (value weighted) over something like the Dow Jones Industrial Average (price weighted).

Not quite. It's not the prices that are used here, but the relative value of what is produced.

Not exactly. There's nothing equal about the production values of various commodities.

The S&P GSCI is rebalanced annually and uses a rolling methodology (how to adjust for expiring futures contracts) of the nearest most liquid contract rather than a more distant contract. How do you think that would affect the way this index responds to supply and demand shocks?

Yes! Using the nearest-term contracts leaves the index most responsive to any supply and demand changes.

Here's a snapshot of these attributes, and how they compare to other indexes like the Bloomberg Commodity Index (BCOM), the Deutsche Bank Liquid Commodity Index (DBLCI), and the Rogers International Commodity Index (RICI): | Attribute | Adoption Year | Number of Commodities | Weighting | Rolling Methodology | Rebalancing Frequency | |---|---|---|---|---|---| | S&P GSCI | 1991 | 24 | Production | Nearby most liquid | Annual | | BCOM | 1998 | 22 | Production and liquidity | Front month to next or second | Annual | | DBLCI | 2003 | 14 | Fixed | Optimized on roll return | Annual | | RICI | 1998 | 37 | Fixed | Front month to next | Monthly |

No, actually. It would be more responsive. Think about it: Using the nearest-term contracts leaves the index most responsive to any supply and demand changes.

The BCOM is selection based, so there's some judgment exercised in determining what belongs in the index. The DBLCI uses active decision making about what contracts to choose in optimizing roll return. And the RICI uses a clustered, fixed-weighting scheme which also is denominated in multiple currencies, introducing those effects to the index value. Suppose that the price of oil doubled one year, and then dropped by half the next. Which weighting do you think would cause a higher ending value to a commodity index?

You got it!

No. The fixed-weight index would actually end up at a higher value.

Think about it in this context: Suppose both indexes started at 80, with oil being half of each index. Both rise to 120 when the price of oil doubles. The production-weighted index is now two-thirds oil, while the fixed-weight index is still fifty-fifty. So when the price of oil drops back to where it was, the fixed-weight index falls by "half of that half" to 90, while the production-weighted index goes back to 80 as it should. So yes, you'll probably continue to see the S&P GSCI used most often in the world of commodity indexes.

In summary: [[summary]]

A price-weighted index

An equal-weighted index

A market capitalization-weighted index

It would be less responsive

It would be more responsive

Fixed weight

Production weight

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