By Amine Bouchentouf
Explosive growth, easy access to markets have made commodity indexes more than a benchmark of performance.
Investing in commodity index funds has become a very popular way for average investors to get exposure to the broader commodity markets. Index funds are now one of the main vehicles to invest in commodities, and this wasn’t the case 10 years ago, not even five years ago. So why have index funds grown in popularity, and do they really offer the best way for investors to get exposure to commodities?
The first commodity indexes were developed by banks and business groups such as Goldman Sachs, UBS, Standard & Poor’s and Dow Jones to track the performance of a basket of critical commodities in the late 1970s and early 1980s. During this period, these indexes were used primarily as performance benchmarks and were rarely used as investable instruments. Fast-forward to today and you quickly see how rapidly this once-quiet segment of the market has exploded in size, volume, visibility and tradability.
Today, there is more than $500 billion of assets tracking the broad commodity index market and that number is growing yearly. That’s a real asset explosion, especially considering the industry only had $5 billion in assets in the late 1990s, according to Barclays Capital Research. Also, the number of commodity indexes has exploded and, just like any expanding industry, the market experienced a consolidation phase. For example, while the original Goldman Sachs Commodity Index (Pending:GSCI) still exists, it was gobbled up by Standard & Poor’s.
The rise of the commodity index can be attributed to several different factors. First, the commodities industry itself experienced explosive growth over the last decade, driven by surging demand for all sorts of key resources such as oil, natural gas, corn and wheat. This led to increasing interest from investors and traders. Previously, it was very difficult to trade commodities if you weren’t a licensed professional operating on the floors of the mercantile exchanges in New York or Chicago.
Secondly, with the advent of the commodity index, any investor can get quick and easy access to the broad commodity markets without opening a futures account and without leveraging their balance sheet 10-to-1 or 25-to-1.
What’s An Investor To Do?
If you’ve never traded or invested in a commodity index, there’s no need to worry: It’s a very straightforward process. That said, you have to be careful which commodity index to invest in. Investors have a wide selection to choose from, and not every commodity index is created equal. Perhaps the most widely tracked commodity index is the Goldman Sachs Commodity Index, the S&P GSCI, which is now part of Standard & Poor’s.
The S&P GSCI Index is the most widely followed in the industry. What you need to know about this index is that it is heavily weighted toward energy and crude oil. Almost 70 percent of the index is energy related; S&P argues that the index is overweight energy because it reflects commodity production where oil is more widely used than corn or wheat. Most commodity indexes now have exchange-traded funds that track their performance, so it’s easy to get exposure to the index of your choice through the convenience of an ETF.
For the S&P GSCI Index, I recommend you take a look at the iShares GSCI Commodity-Indexed Trust Fund (NYSEArca: GSG). GSG gives you the same exposure to the index, along with the added value of daily liquidity ($1.4 in AUM) and daily redemptions.
Another ETF you can take a look at is the PowerShares DB Commodity Index Tracking Fund (NYSEArca: DBC). DBC is the first ETF on the market to track a commodity index fund; in this case, the Deutsche Bank Commodity Index Fund. Unlike GSG, DBC tracks a basket of fixed commodities: two energy commodities, two metal commodities and two agriculture commodities. The DBC is a good ETF if you’re looking for balanced exposure to commodities. Also, with over $6 billion in assets, this is the most widely tracked commodity index ETF in the market.
Another product at your disposal is the ETF that tracks the Rogers International Commodity Index (RICI). The RICI is the index that includes the broadest variety of commodities in the market, and tracks resources such as zinc, lumber and rubber, in addition to the traditional commodities such as crude oil and natural gas. The Elements Rogers International Commodity Index ETN (NYSEArca: RJI) gives you access to the RICI index. At almost $700 million in assets under management, this newcomer is growing fast among investors, and is proving to be a popular alternative to some of the more traditional indexes.
If you’re looking for broad exposure to the commodity markets, commodity index fund ETFs offer you an easy way in. You have a wide variety to choose from, so be selective in terms of what kind of returns you’re looking to achieve.
Disclosure: The author doesn’t have any positions in the stocks mentioned.